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Anorak | Yes, It’s Getting Worse! How The National Debt Works To Make France Go Bust In 10 Years

Yes, It’s Getting Worse! How The National Debt Works To Make France Go Bust In 10 Years

by | 17th, November 2011

THIS eurozone thing again: yup, it’s just getting worser and worser.

Spain and France faced sharply higher borrowing costs on Thursday, struggling with bond auctions that highlighted the threat of larger euro zone economies succumbing to the debt crisis that began in Greece and is now threatening Italy.

What you need to remember about all of this: when we say “higher borrowing costs” here we don’t mean that the country has to cough up more on all its debt…….ah, no, let’s start more simply.

When a government wants to spend more (read, give more goodies to people so they’ll get elected) money than it collects in taxes it issues a bond. This is an IOU saying that we’ll pay you back in 1 month, 10 years, 30 years, promise, and in the meantime we’ll give you some interest. That interest rate they have to pay to convince people to lend them the money is the borrowing cost or the yield.

The amount they borrow each year is called the “deficit” and the total amount that they’ve borrowed and have to repay at some future date is the national debt. These bonds that make up the national debt are traded and like anything that is traded the price can change. When the price changes the interest rate does not: but the yield does. Because the interest rate is calculated at the original issue price and the yield is calculated at the current market price.

Now, when we issue new bonds to cover this year’s deficit, adding to the pile of the national debt, then we have to price them at the same yields as the old debt is trading in the market. So if everyone thinks Greece isn’t going to pay its debts then they’ll sell them, the price will go down and the yield will go up. This is what has happened: Greece issued bonds at 3% interest rate a few years back, the yield on these is now 28% and rising as the price goes through 40% of the original and is still falling.

But! We only have to pay these higher costs on the new debt we are issuing. And we only issue new debt to pay this year’s deficit and to repay the old bits of the national debt that we really must repay this year. So, we don’t pay this higher yield on the entire national debt: we only pay it on the new bits that we’re issuing.

Which should mean that rising yields aren’t all that much of the problem really. That French bond mentioned above was for only €7 billion: in government money that’s nothing. Except for one little further point. France has to pay that higher interest rate for all the life of the bond: maybe 10 years, maybe 30 years. And, as all of the old debt comes up for renewal, then the higher interest rate has to be paid on all of it.

This is what the problem is: it isn’t that everyone suddenly goes bust because yields and interest rates rise. It’s that we can all see that the new, higher, interest rates, if they continue, are going to make them go bust in 10 or 15 years. And if you’re thinking of lending money to someone for 30 years, that’s a bit of a problem really.

It’s nothing at all to do with speculators, derivatives, CDS, greedy bankers or anything like that at all. It’s just straight old arithmetic. As interest rates rise then future interest payments get higher and eventually the government will go bust just because the people will stop paying the taxes to pay the interest.

 

 



Posted: 17th, November 2011 | In: Money Comment | TrackBack | Permalink