Behold the debt spiral | FT Alphaville

Behold the debt spiral

There are many different types of spirals in the natural world. Here are just some:

One characteristic true to all is a curvature that winds progressively further out from a central point — getting larger and larger and larger as it goes.

In which case, should we be alarmed by the increased frequency with which ‘spirals’ are being referenced in connection with the global sovereign debt situation?

For example:

Bloomberg, March 14 – European Central Bank council member Ewald Nowotny said that some euro-region governments may face a “debt spiral” if they don’t starting cutting their budget deficits next year. “The economic situation is still very tense and problematic,” Nowotny told Austria’s ORF television in an interview today.

In 2011, governments have to start pushing down their budget deficits or they “can end up in a debt spiral and consolidation will become costlier and more painful. There are several countries in Europe that see this problem.”

From the Telegraph, November 2009:

OECD warns Britain risks ‘debt spiral’
Britain is at growing risk of a “public debt spiral” unless the Government takes “drastic” action to cut the deficit, according to the OECD, world’s leading economic institution.

And the latest from the Telegraph’s Ambrose Evans Pritchard on Thursday:

Sovereign debt crisis at ‘boiling point’, warns Bank for International Settlements

“The aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to the boiling point”, said the Swiss-based bank for central bankers — the oldest and most venerable of the world’s financial watchdogs. Drastic austerity measures will be needed to head off a compound interest spiral, if it is not already too late for some.

BNP Paribas meanwhile referenced the ‘Fisher debt spiral’ in their note on Wednesday — in connection with the Greek debt situation, of course:

Greek spreads saw a record widening move yesterday. Yield spreads at current levels create a Fisher debt spiral. The final nail in the Greek coffin might be provided by a potential failure of the Greek USD denominated bond issuance planned for later in April. The EUR will remain offered.

David Roche, president and global strategist at Independent Strategy and Bob McKee, economist at Independent Strategy, provide some context. As they explained in the FT on March 31, in most cases economies face a ‘tipping point’ just before they embark upon an unstoppable and destructive spiral debt path.

The so-called “compound interest spiral” — when the debt burden is so large it inevitably begins to fan ever higher interest payments — usually occurs when sovereign debt breaches somewhere in the region of 60-90 per cent of GDP, they say.

As they wrote:

Studies by the IMF and by Reinhart and Rogoff also show that there exists a tipping point – when sovereign debt breaches 60-90 per cent of GDP – beyond which the impact of more state spending is to reduce growth and even to make the economy shrink. Sovereign debt is already (or is set to rise) above such a tipping point in the US, the UK and the eurozone. It is already more than twice that level in Japan. This means rich countries will lack a dynamic core to help them grow their way out of their debt spiral by boosting GDP. Indeed, if growth falls below the yields on their bonds, these countries will become sovereign black holes in the universe of credit, with uncontrollable upwardly spiralling debt levels.

The OECD, meanwhile, explains that the spiral can also be exacerbated as follows:

The debt spiral can be exacerbated where an actual or perceived lack of fiscal discipline leads to continuous upward pressure on interest rates. At the limit, the credibility of central bank inflation control can be undermined if the rate of debt accumulation becomes unsustainable.

With that in mind, we note the goings-on in Greek debt on Thursday, where the Greek bond-German bund spread is at its highest since 1999, and Greek CDS is at a record.

So, is that the sound of a Galactic whirlpool coming our way?

Related links:
Watch out for sovereign black holes in the credit universe
– FT
Greece and the markets, post-bailout plan
– FT Alphaville
US debt saturation *alert* – FT Alphaville
And Greece does go to market
– FT Alphaville