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Wherever did the sovereign debt crisis go? It’s not that many years since many advanced economies’ ability to refinance government debt at a tolerable cost was in serious question. Today, Ireland can borrow for 10 years at a negative interest rate, Spain and Portugal at less than 0.3 per cent, and even Italy and Greece at about 1 per cent per year.
Back in 2011, the number “7” acquired a strangely mythical status. It was commonplace to say that if the yield on a eurozone government’s debt went above 7 per cent, it was game over and it would have to apply for a rescue package enforced by the “troika” of the European Commission, the European Central Bank and the IMF. That number fixation was always a bit silly. The real point is, of course, that the higher the cost of borrowing and the longer the period of elevated cost, the more unsustainable the debt position and hence the more investors would shun a country’s debt. So a debt crisis is a vicious cycle.
How difficult this cycle is to escape depends on a government’s total financing needs. After all, if you do not need to borrow at all, you are invulnerable to any spike in the theoretical cost. If you only need a little, you can afford very high rates (well above 7 per cent!) for some time. For highly indebted governments, this financing requirement depends as much, and often more, on the maturity of outstanding debt than on the size of deficits. What pushed Greece into the arms of the troika in 2010 was not its deficit, huge as it was, but its obligation to repay older debt that it would in normal circumstances roll over at roughly unchanged rates.
All of which means that any country can largely inure itself against a sovereign debt crisis by stretching out the maturity profile of its debt so much that it will never face a period of repayment obligation beyond what it could in principle raise through budget consolidation. Even a country with debt equal to 100 per cent of gross domestic product could, say, stretch it out over 50 years to face only 2 per cent of GDP worth of repayments every year. And there is no better time to do this than when long-term interest rates are particularly low.
Debt managers in the eurozone have been doing precisely this over the past decade. The ECB has been a good handmaid to this effort: by lowering rates across the eurozone, they have made it easier for cost-conscious governments to move out the maturity curve without feeling out of pocket.
As I wrote a year ago, the OECD has reported that its members, on average, increased the average residual maturity of their debt from six years on the eve of the crisis to eight years a decade later, with many eurozone countries even well above this. Even so, the latest update from the OECD states that “the volumes of scheduled redemptions of some euro area countries, particularly France, Italy and Spain, are fairly substantial for the next few years”. There is clearly potential to go much further.
Whenever I have a chance, I ask debt managers why they do not shift more of their debt into very long-term liabilities, such as 50- or 100-year bonds. The answer is twofold: cost and liquidity. The yield curve slopes upwards, or in non-jargon, it costs more to borrow for longer than for shorter terms. That is not all: governments may also find that their bonds’ spread over benchmark bonds, such as German Bunds, increases with the maturity of the debt in question.
As for liquidity, the very long-term issues tend to have few buyers, despite the often-expressed wishes from pension funds and other institutional investors for safe long-term investments. So a prudent debt manager will worry about the risk of a few hedge funds holding the entire issue, and the chaos they can cause if they change their mind and drop the bond. This lack of liquidity, of course, contributes to the higher cost of borrowing at ultra-long terms.
Even these are not conclusive arguments. The higher cost may arguably be a price worth paying to eliminate the risk of a refinancing crisis. And governments can tilt their issuance more towards the longest maturities that do have liquid markets, such as 30-year bonds.
But more fundamentally, we should recognise that thin markets for ultra-long bonds are a chicken-and-egg problem. There is little demand because there is little liquidity, and there is little liquidity because there are few buyers. The presence of some sort of market maker could bring in the many prudent investors who are looking for long-term placements but need to know they can get out.
This is a task for the ECB, which has confined its quantitative easing programme to buying bonds between two and 30 years of maturity. It could help create more liquid markets in longer-term debt by lifting the upper limit, and tilting the weight of its portfolio from the shorter to the longer maturities, akin to the Federal Reserve’s “Operation Twist” early in the last decade. This would reduce the relative expensiveness of extending funding maturities. But, above all, it would help underpin a liquid market for very long-term debt by assuring investors that the central banks treat such securities as a regular instrument for their monetary policy interventions.
The continuing low-interest environment and sluggish growth have led many economists to talk seriously about “fiscal-monetary co-operation”. This is usually meant in the sense that central banks should guarantee low financing costs for governments in order to coax them into doing more fiscal stimulus and relieve monetary policy of some of its burden in managing the macroeconomy. Explicit arrangements of this sort are, however, dangerous territory, and far too close to “monetary financing” for the comfort of many.
An ECB Operation Twist, in contrast, is something the central bank could legitimately initiate on the basis of its secondary mandate to “support the general economic policies in the union”, which presumably include financial stability. At the same time, it could communicate that it would welcome longer average sovereign maturities for financial stability reasons. That would be fiscal-monetary co-operation well worth having.
Other readables
- Joshua Kirschenbaum and Nicolas Véron explain why and how the EU must establish an anti-money laundering agency, and soon.
- Simon Kuper asks whether the Netherlands will save the world from climate change with its experience of flood prevention — and ends up wondering if the Dutch can even save themselves.
Numbers news
- Free Lunch has a strong interest in regional inequality. Now a new study charts the relative development of the Spanish regions (the black line on the chart below traces the dispersion of regional per capita income over time). In Spain, as in so many other places, poorer regions were catching up fast with richer ones in the middle of the last century, but that convergence came to a halt in the 1980s.
Source: Economy - ft.com
