Visualizing Debt Detonation Rates Around the World
Recently we looked at the critical chart in sovereign debt analysis which painted a broad picture of how vulnerable sovereigns are to rises in interest rates. Well, today we thought we’d show you a couple of charts that should be paired with it. By the end of this piece you’ll have a good idea of the average debt costs that would detonate the accounts of major governments around the world.
The first thing we have to look at is public debt to central government tax revenue ratios. As mentioned previously:
[This gives you] a direct feel for how increases in interest rates affect government accounts. For example, when public debt is 10X government revenue then a 1% increase in the average interest rate paid on public debt forces the government to use an additional 10% of its revenues for paying interest. In short, this metric gives you a clear idea of just how easily a government could reach the keynesian endpoint (i.e. the point at which all of government revenues are used to pay interest alone).
As you can see, there’s one clear leader below… Japan. Even all the way back in 2009 (which is the year of the data used below) public debt was 20x central government tax revenue. If Japan’s average interest costs were to rise even a little it would take out a big chunk of central government tax revenues.
But it does depend on another thing too; the proportion of central government tax revenue that is already being spent on interest. So below we’ve got a chart of interest expense as a % of central government tax revenue for the same countries:
So the final thing is to put these two concepts together. In the first chart we have a metric that shows the vulnerability of a sovereign to interest cost changes, and in the second we have a concrete fact about how significant interest expense is already. Now we can compare the rate that sets interest expense equal to revenue with the average debt cost. The basic question is; what % increase in a sovereign’s average debt cost would force them to pay all of their central government tax revenue in interest? Because if that point was reached they would have to borrow everything they spend …including the interest that would acrue on that borrowing… and you can see how things would spiral out of control very quickly.
So if you look at the chart below you can see the debt cost rate (yearly interest expense / public debt outstanding) in turquoise and the detonation rate in red. The countries at the top are in a relatively sound situation, and as you go down things get worse. You can see that some of the major developed nations are towards the bottom of the chart. Such is the problem with the zero interest rate policy; you get stuck in a situation where your detonation rate approaches your actual cost.
Finally we have to mention Japan once again simply because of the wild disparity that is present today. Creditors are charging the Japanese government record low interest rates at a time when their detonation rate is just a few hundred basis points (if that) away…
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012