« The law-makers' fallacy | Main | "Natural limits" of social democracy »

March 21, 2010


john b

I agree with your piece 100%; however, commenters on both sides of the argument tend to conflate default risk (which does not exist: anyone who thinks there's a chance that approximates to more than zero of any UK government defaulting on its debt is literally insane) with currency risk (which certainly does; anyone who buys sterling bonds right now is doing so in the belief that speculators have short-sold the currency to buggery, whereas the belief that we'll be long-term at even lower rates than at present is perfectly tenable).


To be creditworthy is to be considered able to repay a loan in full. Both inflation and currency depreciation impact the repayment value and should therefore be considered in assessing creditworthiness. Credit rating agencies and the credit departments of banks certainly take inflation and currency into account when assessing a credit.


Gaw: you just did the thing which John B talked about in the comment right before yours; as a result, your use of the terms 'in full' and 'value' are equivocal. Did you even read what he wrote?


Just because I don't accept an argument doesn't mean I haven't read it. My point is exactly that creditworthiness is a conflation of default, inflation and currency risk (indeed, this is practically a truism). I'm not sure it makes sense to talk of a 'pure' measure of creditworthiness - the notion of credit is composite. I therefore think Forsyth's point is broadly reasonable.

Richard W

@ Gaw
There is zero default risk on gilts. The credit rating agencies do not take account of de facto defaults through inflation when rating sovereign debt. With gilts there is a market risk as interest rates are thought likely to rise earlier in the UK compared to the ECB. The currency risk only really affects overseas buyers. This currency risk would contribute to a liquidity risk that holders may not easily be able to sell their gilts and it is this that pushes up yields.


Richard W: My point about creditworthiness is a general one - I agree with everything you say about gilts. Again, my point is a simple one - many risks go up to make credit risk. You can't set inflation and currency risks to one side when discussing creditworthiness, which is what I believe Chris is doing.


«One obvious way in which this would happen would be if we could engineer a massive inflation. This would make it easier to repay (devalued) debt, but would raise gilt yields. This is no mere possibility. It’s just what happened in the late 1960s and early 70s»

Not just a mere possibility -- check out the graph for oil export from the UK and correlate with its likely effect on the strength of the pound:


Note that 1982-2007 oil exports have massively contributed to the UK balance of payments (which probably explains 100% of the "success" of Thatcherism first and New Labour later, both founded on a strong currency and rising imports) and what it means for the currency risk of foreign holders of sterling IOUs.

Also note that Blair handed over to Brown in precisely the same year that the oil flow went from net positive to net negative. "you are it" seems to have logic :-).


"the market thinks there’s more chance of sterling falling against the euro than of Italy leaving the euro".

more accurate perhaps to say:

"the market expects italy's exchange rate vis-a-vis sterling to be higher in 5yr than now"

On the exchange rate there are 5yr forwards for exchange rates and - this should be taken with a pinch of salt as I used dollar forwards and wasn't quite sure how to do the calculation - I think they are suggesting a 0.5% appreciation of the euro v sterling per year over the next 5 years.


It should also be pointed out that the average maturity on UK government debt is a fair bit longer than for Italy.

Robert Prime

Although most lenders have a few credit guidelines that are unique to their operation, most rely heavily on the information they obtain from the credit reference agencies to determine your credit worthiness.

The comments to this entry are closed.

blogs I like

Blog powered by Typepad