Currencies punching above their weight

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I recently enjoyed lunch with a group of former colleagues. At one point, the conversation turned to the Australian dollar, a natural enough topic for a bunch of finance types. Someone observed that the Aussie is the 5th most actively traded currency in the world, which is impressive since Australia is certainly not the 5th largest economy in the world (that honour currently goes to France).

Thinking about Australian dollar punching above its weight led me to wonder which country had the most actively traded currency relative to the size of its economy. A quick vote around the lunch table came up with four candidates: the Australian dollar, the New Zealand dollar (which is much beloved by hedge funds), the Swiss franc and the Norwegian krone. The most popular choice among these was the Australian dollar. I was wavering between the New Zealand dollar and the Norwegian krone, but none of us knew the answer. That meant only one thing: a Stubborn Mule post would ensue to settle the bet.

Starting with turnover in the chart below, it is no surprise that the US dollar is by far the most actively traded currency. Not only is the United States the largest economy in the world, but an enormous amount of international trade is conducted in US dollars, and sellers and buyers have to transact in the currency markets to convert US dollars to and from their local currency.

Top 10 Currencies by Turnover (2010)

There are a number of reasons the Australian dollar is traded as much as it is. Our higher interest rates attract many into the carry trade (borrowing in low interest rate currencies, investing in higher interest rate currencies and hoping that the currency you are buying does not collapse). As a very commodity-driven country, many international investors see investing in Australia as a proxy for investing in commodities and, more particularly, jumping onto the China growth band-wagon. For many investors, simply buying the Australian dollar is cheaper and easier than investing in our stock-market.

But back to our bet. Only one of the assembled diners picked the Swiss franc, but it turns out to be at the top of the league table. With a GDP in 2010 of US$500 billion, there was average of $253 billion traded in Swiss francs every day in April 2010!

I have never made a close study of the Swiss franc, so I would be very interested in hearing any theories people may have as to why it is so heavily traded.

Next in the list is New Zealand, so my instincts were right there (let’s not mention the fact that I also tipped the Norwegian krone which came in a disappointing 11th place). Interestingly, third and fourth place, the Hong Kong and Singapore dollar respectively, did not even make it into our short list. And it turns out that the Australian dollar ranks 5th not only in terms of outright turnover, but also in turnover relative to economy size.

Top 10 Currencies by Daily Turnover relative to Annual GDP (2010)

If you are interested in exploring the league table further, the table below has all of the data.

Currency	Daily Turnover (US$)	Annual GDP (US$)	Turnover/GDP (%)
Swiss franc	253	500.3	50.6
New Zealand dollar	63	128.4	49.1
Hong Kong dollar	94	215.4	43.6
Singapore dollar	56	181.9	30.8
Australian dollar	302	1013	29.8
US dollar	3378	14440	23.4
Pound sterling	513	2680	19.1
Swedish krona	87	479	18.2
Japanese yen	755	4911	15.4
Canadian dollar	210	1500	14
Norwegian krone	53	451.8	11.7
Hungarian forint	17	155.9	10.9
South African rand	29	276.8	10.5
Euro	1555	18140	8.6
Danish krone	23	340	6.8
Korean won	60	929.1	6.5
Polish zloty	32	527.9	6.1
Malaysian ringgit	11	221.6	5
New Taiwan dollar	19	391.4	4.9
Mexican peso	50	1088	4.6
Philipine peso	7	166.9	4.2
Turkish new lira	29	730	4
Chilean peso	7	169.5	4.1
Czech koruna	8	216.4	3.7
Indian rupee	38	1207	3.1
Israeli new shekel	6	202.1	3
Thai baht	8	273.3	2.9
Russian Rouble	36	1677	2.1
Brazilian real	27	1573	1.7
Colombian peso	4	240.8	1.7
Indonesian rupiah	6	511.8	1.2
Chinese renminbi	34	4327	0.8
Saudi Riyal	2	469.4	0.4
Other currencies	190	NA	NA

Data sources
Currency turnover: Bank for International Settlements (BIS)
GDP: CIA World Fact Book (official exchange rates)

Bedside book pile

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Just as topics for blog posts are piling up, so are the books on my bedside table. I have always read more than one book at a time, but things are getting out of hand at the moment, and that doesn’t even take into account the books I have on the Kindle.

In an effort to prioritise my reading and clear a few from this precarious pile, I thought I would take a look at some of the books here on the blog.

Mistakes Were Made (But Not by Me) by Carol Tavris, which was the subject of my last post, is a fascinating examination of cognitive dissonance. I was only about a quarter of the way through the book when I was inspired to write that post and now that I have nearly finished, it has not disappointed. Topics as diverse as suppressed memory syndrome, what makes relationships succeed or fail, international conflict, racism, bullying and false convictions are all examined through the lens of cognitive dissonance. It only ended up at the bottom of the pile when I stacked the books for the photo, so it should come straight out and be the first one I finish.

I started reading Javascript: the Definitive Guide by David Flanagan quite a while ago when I was playing around with the charting tool Protovis. At the time I had some ideas for doing more than a few blog posts, but I’m a bit too busy to take them any further at the moment. Much as I would like to improve my facility with Javascript, I think this book should be retired back to the bookshelf for now.

A friend was working in Japan back in 1995 and was unlucky enough to be caught in the sarin attack on the Tokyo subway. I had spoken to him about it a few times when I came across the book Underground: The Tokyo Gas Attack and the Japanese Psyche by Haruki Murakami. Best known for his fiction, Murakami turned to non-fiction for the first time with this series of interviews with survivors of the attack. It makes for grim reading and so, as each chapter focuses on the story of a single interviewee, I have taken to reading a chapter or two at a time, turning to lighter subjects in between. This one can stay on the table.

Playfair’s Commercial and Political Atlas and Statistical Breviary by William Playfair is the oldest book here. Written in 1801, I regularly dip into this one for the pictures not the words. Regular visitors to the Stubborn Mule will know I am a chart enthusiast and William Playfair is one of the greatest pioneers in the field of visual representation of quantitative information. He is credited with inventing some of the most fundamental tools in the charters toolbox: line charts, bar charts and even pie charts. For a couple of years now I have meant to write a post about Playfair and this book can also stay on the table, at least until that post gets written.

At this point it is starting to seem as though I only read non-fiction. That is not quite true and there are two novels here: American Pastoral by Philip Roth, which I have started and Anathem by Neal Stephenson which I have not. Given how long it took me to get through Stephenson’s Baroque Cycle, I should really finish American Pastoral before I embark upon Anathem.

Given how long this post is already, there are clearly too many books to list here (and likewise too many to finish any time soon), but for the benefit of those readers who enjoy my posts about money and debt, I should point out that Monetary Economics by Wynne Godley and Marc Lavoie is there too. There is plenty of future blog material in that book, I have no doubt.

Cognitive dissonance

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Let’s say you think of yourself as a good person (bear with me for a moment if you don’t). Now you do something nasty to somebody. This leaves you with two contradictory thoughts in your mind: “I am good” and “I am nasty”. In George Orwell’s Nineteen Eighty-Four, “doublethink” is quite routine, but in practice conflicting thoughts are a source of discomfort. This discomfort is known as “cognitive dissonance”.

Even if you don’t think you are a good person, you are not immune from cognitive dissonance. It can arise in all kinds of situations: perhaps you hear a reasonable argument against one of your firmly-held beliefs, perhaps a decision you take turns out badly, perhaps someone you consider a friend lets you down or someone you dislike does something to help you.

Whatever the cause, our brains tend to work hard to “resolve” the dissonance and explain away the contradiction (that person really deserved the nasty thing you did). This tendency is the source of a wide range of irrational behaviour, many of which are explored in the book I am reading at the moment: Mistakes Were Made (But Not By Me) by Carol Tavris and Elliot Aronson. The title itself gives just one example, the fact that we tend to explain away our mistakes: there were, of course, mitigating circumstances and were really all the fault of others.

One interesting theory in the book relates to prejudice. Stereotypes, particularly racial or religious ones, are often considered a contributing cause of prejudice. The authors suggest that the causality in fact runs the other way. People have a strong tendency to form groups and then feel not only a bond with others in the group but an antipathy to those outside the group. Obvious examples are nation, race, religion or football team, but group identification can be made in all kinds of ways. The book relates an experiment in which subjects were asked to estimate the number of dots shown on a flash card. After a preliminary round, each person was told whether they were an “under-estimator” or an “over-estimator”. As further tests were conducted, the results were announced to the group and in no time at all, under-estimators were cheering the successes of other under-estimators and boo-ing the successes of over-estimators, and vice versa. While under and over-estimators would never go to war, it is sobering to see how rapidly people can divide themselves into the in-crowd and the out-crowd. With this in mind, Tavris and Aronson argue that prejudice comes first, the result of disliking those outside your own group, and the stereotype comes later to explain this dislike:

By understanding prejudice as our self-justifying servant, we can better see why some prejudices are so hard to eradicate: They allow people to justify and defend their most important social identities‚ their race, their religion, their sexuality‚ while reducing the dissonance between, “I am a good person”‚ and “I really don’t like those people”.

So perhaps prejudice causes stereotyping not the other way around.

Like so many cognitive biases, the tendency to resolve cognitive dissonance is something you can take advantage of. Although Benjamin Franklin was around well before cognitive dissonance was given a name, he clearly understood the phenomenon. He relates the following story in his autobiography:

Having heard that he had in his library a certain very scarce and curious book, I wrote a note to him, expressing my desire of perusing that book, and requesting he would do me the favour of lending it to me for a few days. He sent it immediately, and I return’d it in about a week with another note, expressing strongly my sense of the favour. When we next met in the House, he spoke to me (which he had never done before), and with great civility; and he ever after manifested a readiness to serve me on all occasions, so that we became great friends, and our friendship continued to his death. This is another instance of the truth of an old maxim I had learned, which says, “He that has once done you a kindness will be more ready to do you another than he who you yourself have obliged.”

I am keen to try this trick myself, so if you don’t like me and want to keep it that way, think twice about doing me any favours.

Cognitive dissonance is a fascinating phenomenon, but simply studying does not make you immune from its grasp. Still, Tavris and Aronson suggest that there are ways to try to inoculate yourself:

We need a few trusted naysayers in our lives, critics who are willing to puncture our protective bubble of self-justifications and yank us back to reality if we veer too far off. This is especially important for people in positions of power.

That is advice I try to heed here on this blog. Whether I am arguing about property prices, government debt and deficits, climate change or any other topic, I welcome comments that argue against my position. I do not want to live in a bubble.

Looking beyond the financial crisis

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The IMF has been busy of late, what with their attempts to stave off European sovereign defaults and shenanigans of its erstwhile managing director, Dominic Strauss-Kahn. I have been busy too (for rather different reasons I hasten to add) and so it has taken me a while to get to looking at the IMF’s most recent World Economic Outlook (WEO) report, which was released back in April.

The WEO is prepared twice a year and, whatever one’s views of the merits of the economic ideas of the IMF and their role on the world stage, the report provides a rich source of data and includes both historical data and five-year forecasts.

I was interested to compare the effect of the global financial crisis on the most challenged euro nations, the so-called “PIIGS”, Portugal, Ireland, Italy, Greece and Spain, to a few other countries. To account for differences in population and currencies, I chose Gross Domestic Product per capita expressed in US dollars as the measure for this comparison*. Even so, care needs to be taken in interpreting the results. Exchange rates do introduce a fair degree of volatility as is evident in the chart below: the trajectory of US GDP per capita is quite steady, although the downward dip over recent years is clearly evident, while the paths for every other country wiggle up and down with the vagaries of currency markets. Nevertheless, it is striking to see the IMF projecting that Australia will dramatically outpace the other countries in this group, thanks to the combination of a resources boom and escaping relatively unscathed from the financial crisis of the last few years. I should point out that, while taking the gold medal in this group, Australia is not the overall winner in the IMF 2016 forecast stakes. That honor goes to the small nation of Luxembourg, and Qatar is not far behind.

History and IMF forecasts of GDP per capita (in US$)

An alternative approach that seeks to eliminate exchange rate effects is to work in local currencies and make these comparable by scaling to a common base at some point in the past. Somewhat arbitrarily, I have chosen to base this comparison on 1996, which gives a 20 year span including the forecasts out to 2016. This time I have used inflation adjusted figures**. Interestingly, this approach sees Ireland coming out on top, which reflects the strength of their economic boom over the period immediately up to the start of the crisis.

History and IMF forecasts of GDP per capita (local currency index)

This chart shows even more clearly how unaffected Australia was by the financial crisis compared to other countries. Once again, these results should be treated with caution. Any comparison like this will be very dependent on the year chosen to base the indices. If only I had chosen the year 2000, Australia would be in the lead again!

* This is the IMF series NGDPDPC.
** This is the IMF series NGDPRPC, rebased to 100 in 1996.

Gibbons and welfare

Why deficits are bad

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There have been many posts here on the blog arguing that government debt and deficits should not be feared, at least not in countries with their own free-floating currency and without foreign currency public debt*. In doing so, I have never discussed the reasons people may have for holding a contrary view. But I have now come across a rather disturbing theory on the news site Alter.net.

It may be that there are some who would like to see an end to government deficits because they adhere to the Chicago school of economics and scoff that Keynes was thoroughly discredited by the stagflation of the 1970s. There may be others who challenge supporters of government spending with a simple question: if too much debt was the cause of the financial crisis, how could more debt be the answer? (Of course, regular readers of the blog will know the answer to this one: the debt build-up before the crisis was private sector debt and for the private sector to reduce debt by saving again, the government must run a deficit**). Still others may think that deficits cause recessions (rather than recessions causing deficits).

But the theory offered by Alter.net is simpler still. Perhaps people think national debt is bad because it actually means a bad economy. Literally. They just do not understand the meaning of the words.

The evidence offered goes back to a US presidential debate from 1992. In the debate, an audience member asks the candidates the following question:

How has the national debt personally affected each of your lives. And if it hasn’t, how can you honestly find a cure for the economic problems of the common people if you have no experience in what’s ailing them?

If you watch the resulting exchange here, it quickly becomes clear that, in the questioner’s mind, “national debt” is in fact synonymous with “recession”. National debt doesn’t cause unemployment, it is unemployment!

Of course that clip is almost 20 years old and it is America, not Australia. But it still worries me. Could it be that part of the reason that it is so hard to have a rational debate about debt and deficits is that some (or even many) of the voting public do not understand what the debate is about? I hope not!

* So the eurozone is a different matter altogether!

** Either that or run a current account surplus…which is still something we have not achieved in Australia.

Action and reaction on climate change

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Regular guest contributer James Glover (@zebra) takes a closer look at the Coalitions climate change policy.

Malcolm Turnbull, an Australian MP, did a rare and risky thing last week. He actually broke away from the political spin-cycle and explained some figures underlying the cost of the Coalition’s “Real Action on Climate Change” policy. Naturally he was attacked by both the Labor government, who are having trouble selling their own Carbon Tax policy, and his own party colleagues who were horrified that he didn’t stay “on message”. The Coalition quickly bunkered down under orders from the top to avoid discussing Turnbull’s “outburst”. So what was he saying anyway and why was it so controversial?

To see why we need to explain the difference between the Labor Party and conservative Coalition’s policies. There are really only two broad differences. Both policies recognise that anthropogenic climate change is scientific fact, not speculative political fiction. Both recognise the need for action (ie. spending money) on combating climate change. But where they differ is in how global warming should be reversed and how to raise the money to do so. It is not commonly understood but the real difference between the policies is the former.

The Carbon Tax (or its close relative the CPRS) aims to reduce carbon emissions by making carbon pollution relatively more expensive than cleaner, alternate sources of power (and really it’s all about power generation). In order to do this they need to raise the price of carbon powered energy sufficiently to tip the balance in favour of wind, wave, geothermal, biofuels or solar energy (as explained in a recent post here on the Mule). Of the money raised by the Carbon Tax, about half goes back to subsidising the increased power bills of the less well-off. Of the remainder, most goes to developing cleaner sources of energy at lower cost. As explained in the earlier post, when there is no more carbon pollution then there is no more carbon tax to distribute. So ultimately, unless the cost of alternate energy comes down to the levels currently enjoyed by coal, gas or oil based power, in the long run the less well off will be much less well off.

While the Coalition’s “Real Action on Climate Change” has more than a whiff of policy-on-the-run, it can be presented as a respectable alternative. It says that we should ignore the fruitless and expensive attempt to cheapen alternative power and accept carbon pollution as a fact of life. In order to mitigate the effects of carbon pollution, though, we need to remove it from the atmosphere after the pollution has occurred, not at the source. This will cost money. A lot of money. Australia alone currently produces about 0.2 billion tonnes of carbon (not C02) each year. That’s a cubic block of carbon approximately 500m x 500m x 500m*. Each year. Anybody who thinks sequestration is the answer has to find somewhere to put all that carbon for a start. Or plant several million trees a year. The only hope for this reactive approach to reducing carbon is that some method is found which removes large amounts of carbon from the atmosphere at a relatively small cost: and much smaller than the likely Carbon Tax price of $20-40 per tonne. While such methods are conjectured, for example spreading iron filings in the ocean to increase carbon uptake by marine organisms, to say they are untested is an understatement. Equally we could allow carbon to increase in the atmosphere but mitigate the effects of global warming by using giant sunlight reflecting shields. Or paint the Sahara Desert white. Hey, stranger things have happened. But at the moment all these methods remain firmly in the province of science fiction.

So what did Malcolm Turnbull actually say that was so exciting to friend and foe alike? Well, using Treasury forecasts of population and economic growth, that 500m carbon cube will have grown to 850m wide by 2050 (650m tonnes) if we do nothing. Assuming we can mitigate the effects of carbon pollution, or pay someone else to do it for us, the cost could be as low as $15 per tonne or $18bn per year. Assuming the population has doubled by 2050 that’s about $500 per person, or an extra $50 per week on the average household tax bill. Given the extreme rubberiness (definitely not vulcanised rubber) of these figures, that’s pretty much what the Carbon Tax will cost as well. If the initial price of the Carbon Tax is set at $30 per tonne, then over time this should come down as alternate energy becomes actually cheaper due to technology improvements and economies of scale, not just relatively cheaper. Indeed if the Real Action plan involves buying permits from other countries who have set up some sort of CPRS and use alternate energy sources, then the equilibrium cost of both plans is probably pretty much the same, i.e. $15 per tonne. The real action policy really only comes out ahead if one of the fanciful ideas for removing carbon en masse, post production, pays off.

Of course the Coalition’s policy has to be funded somehow, and herein lies the second difference between the two. The Coalition’s policy will involve raising taxes, and probably income taxes as opposed to the Carbon Tax favoured by Labor. So any claim on the Coalition’s part (a point made by Mr Turnbull) that the major benefit of their policy is that it won’t raise electricity prices is totally spurious. Both policies will lessen household discretional spending. By the same amount. That’s all voters ultimately care about. Turnbull also claimed that their policy had the advantage that if “climate change is crap” as Tony Abbot famously is purported to have said, then it can all be dismantled without much cost. For that statement alone, sending a dog-whistle to his party’s climate skeptic supporters, Mr Turnbull deserved the public flaying he got, if not for the right reason.

*Note: in the above I have assumed that 1m cubed of carbon weighs 2 tonnes which is the density of graphite. It obviously depends on the form of carbon used. It is intended as an indicative figure only. Though I wish someone would actually build a structure of that size and point out to everyone this is how much carbon a year we are producing

Online music going backwards in Australia

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We have never been spoiled for choice when it comes to internet music providers in Australia, and things seem to be getting worse not better.

Five or six years ago, I first came across the intriguing internet radio service Pandora which drew upon the painstakingly assembled Music Genome Project to generate customised radio stations. Entering a track or artist on the web site would produce a playlist of “genetically” similar music and the results were impressive. Back then I was able to stream Pandora via my Squeezebox network music player. But it wasn’t long until the music copyright police got onto Pandora and Australians visiting the website would simply see a page explaining why the service was not available. I was lucky enough to still be able to play Pandora stations over the Squeezebox for another year until they discovered that loophole and shut it down.

The on-demand music streaming service Rhapsody has never been available in Australia. Rhapsody’s newer challenger Spotify is also unavailable here and I must admit to a little Schadenfreude when I learned that Spotify is yet to become available in the US. Although I am sure it will be available there before we get it.

With all of these services denied to music-lovers down-under, I had to make do with Last.fm which generated custom stations based on listening habits of other users whose tastes overlapped with your own. Founded almost 10 years ago in London, Last.fm was bought by CBS four years ago, which made me nervous for a while, but the service seemed to continue as usual. Until this February when Australian listeners, and listeners in many other countries around the world, found their Last.fm service abruptly discontinued.

Options for online music should be expanding, yet here in Australia we have fewer services available than we did five years ago.

Return of the Drachma?

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It has been reported that Greece is considering leaving the euro and re-establishing its own currency*.

More than a year ago, I argued that being part of the euro seriously exacerbated Greece’s economic woes, and for the reasons given there, I do think that re-establishing sovereignty over its currency is in Greece’s interests in the long run. Nevertheless, it would be a painful process exiting the monetary union.

To begin with, there are all sorts of practical complexities. The switch to the euro was an enormous project, years in the planning and to switch back would require major logistical and systems changes for banks and businesses across the country. Mind you, the work involved may act as a stimulus to employment! The other challenge, is that Greece still has significant quantities of public and private debt denominated in euro. Inevitably, there would be defaults and restructuring of this debt. That, combined with the fact that the new currency would be launched by a country known around the world to be in dire economic straits, would result in ongoing weakness of the new currency. While a weak currency would have some advantages, making Greece’s exports far more competitive than they have any hope of being while the country retains the euro, imports would become very expensive and there would be significant inflationary pressure. The problems Iceland has faced since its default provide a useful comparison, although Greece does have the advantage of a broader domestic production base.

So, while an exit from the euro would be an unpleasant experience, it is probably just the medicine that patient requires.

* Thanks to @magpie for drawing this article to my attention.

S&P being silly again

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The debt rating agency Standard and Poor’s (S&P) has placed their rating of the US on negative outlook. What this means is that they are giving advance warning that they may downgrade their rating of the US from its current AAA level (the highest possible rating). Their actions were motivated by concern about “very large budget deficits and rising government indebtedness”.

To me this shows that S&P do not have a good enough understanding of macroeconomics to be in the business of providing sovereign ratings. How can I doubt such an experienced and reputable organisation as S&P? Well, keep in mind that this is the same agency which maintained investment grade ratings for the likes of Bear Stearns, Lehman Brothers and AIG right up to the point where these firms were on the brink of collapse (while it was only Lehman that actually failed, that was only because the other two were bailed out). Likewise, it is the same agency which assigned investment grade ratings to sub-prime CDOs and other structured securities many of which only ended up returning cents in the dollar to investors during the global financial crisis.

Of course many commentators are very nervous about the growth in US government debt (notably, the bond market seems far more sanguine) and typically assert, with little justification, that growing government debt will lead inevitably to one or more of:

a failure of the government to be able to meet its debt obligations,
rising inflation as the government seeks to deflate away its debt (and interest rates will rise in anticipation of this future inflation), and
a collapse of the currency as the government seeks to devalue its way out of the problem.

Before considering how likely these consequences really are, it is important to emphasise that while there is a widespread tendency to label all of these as a form of “default” by the government it is only the first of the three, a failure of the government to make its payment obligations, that the S&P rating reflects.

In fact, I do not consider any of the three consequences above to be inevitable. The quick and easy counter is to point to Japan. As its government debt swelled to 100% of gross domestic product (GDP) and beyond, it never missed a payment, would have loved to generate a bit of inflation but consistently failed year after year and, while its currency has its ups and downs, the Yen remains one of the world’s solid currencies. While I certainly do not think that the US should aspire to repeat Japan’s experience over the last couple of decades (I would hope for a better recovery for them), this point should at least dent the simplistic assumption that default, inflation or currency collapse follow rising government debt as night follows day.

Since it is only a true default that is relevant for the S&P rating, it is worth considering more specifically how likely it is that the US government will be unable to honour its debt obligations. Regular readers of the blog will know that I regularly make the point at the heart of the “modern monetary theory” school of macroeconomics, namely that in a country where the government is the monopoly issuer of a free-floating currency, the government cannot run out of money. If your reaction to that is “of course they can print money, but that would be inflationary!”, ask yourself why that did not happen in Japan and then remind yourself that even if it did happen, it is not relevant to the S&P rating.

There is one important caveat to this monopoly issuer of the currency argument. While it certainly establishes that the US government will never be forced to default on its debt, it is still possible that it could choose to default. This choice could come about in a dysfunctional kind of way since the US imposes various constraints on itself, in particularly a congress legislated ceiling on the level of debt the government may issue. So it is possible that a failure of congress to agree to loosen these self-imposed constraints could end up engineering a default. Now that is a more subtle scenario than the one that S&P is worried about, but since it is possible, it is worth considering how serious debt-servicing is becoming for the US government. To make a comparison over time meaningful, I will take the usual approach of looking at the numbers as a proportion of GDP. Taking the lead from a recent Business Insider piece*, the chart below shows US government interest payments as a share of GDP rather than the outright size of the debt. This has the advantage of taking interest rates into account as well: even if your debt is large, it is easier to meet your payment obligations if interest rates are low than if they are high.

US federal government interest payments as a share of GDP

So the interest servicing position of the US government has actually improved of late and is certainly much better than it was in the 1980s and 1990s. So why is S&P reacting now? I would say it is because timing is not their strong suit (and they do not really understand what they are doing). Ahh, you say, but what happens when interest rates start going up? Since the US Federal Reserve controls short-term interest rates and of late, through its Quantitative Easing programs, has been playing around with longer-term interest rates as well, the US government is in a somewhat better position than a typical home-borrower, and interest rates will only start to rise once economic activity picks up again. Then the magic of automatic stabilisers come into play: tax receipts will rise as companies make more profit and more people are back at work, and unemployment benefits and other government expenditure will drop and the growth of government debt will slow or reverse.

So, there is no need for panic. Once again, the rating agencies are showing that we should not be paying too much attention to them. After all, as they all repeatedly said in hearings in the wake of the financial crisis, their ratings are just “opinions” and not always very useful ones at that.

Data Source: Federal Reserve of St Louis (“FRED” database).

* As Bill Mitchell, @ramanan and others have noted the Business Insider chart, while looking much the same as my chart, has the scale of the vertical axis out by a factor 10.