It makes sense to lend to governments

Alexis Tsipras © Getty images
Greek PM Alexis Tsipras: a good credit risk

No matter how ramshackle or indebted the country, buying its bonds is rarely a bad idea.

Earlier this year, Greece successfully managed to complete its first bond issue since the debt crisis of 2010 and it is planning another one over the summer. The country has already raised €5bn from the markets this year, and has indicated another €5bn will be sold in June. On the day, the bonds had little trouble finding buyers. This for a country with a debt-to-GDP ratio of 180% that just about everyone agrees is unsustainable, and which has only just started to grow again after the deepest and longest recession of modern times. Greece also has a long record of defaulting on its debts – it first reneged in 1826, and has failed to pay what it owes on another six occasions since then. On the surface, it is hard to think of any country you would be more reluctant to lend your money to.

Or take Italy. Its debts have climbed to an equally unsustainable 133% of GDP, its banks are close to collapse, and it has a populist government in power committed to lavish spending increases, and which has openly flirted with leaving the euro and replacing it with a parallel currency that would immediately plunge in value (and in which your Italian bonds would presumably be repaid). Yet there are plenty of buyers for Italian debt. A 30-year bond issue in February drew a record number of bids, and while the yield on its ten-year debt at 2.4% is higher than for Germany or Britain, it is hardly astronomical. If it is going to default, no one is worrying about it at the moment.

Likewise, Argentina. It is another serial defaulter, and has a huge range of economic challenges, yet last year it managed to issue 100-year bonds. No one seemed bothered by the idea of lending it money until 2118. Crazy? Complacent? Perhaps not. A new paper from the National Bureau of Economic Research in the US has crunched the numbers on international sovereign bonds from 1815 to 2016. It found that, even when defaults were taken into account, they still performed better than either domestic bonds or equities. It took the data from after the Battle of Waterloo, which is when the market in international debt started in London, and worked out the returns over the next two centuries. If you had put your money into a portfolio of US Treasuries you would have made 4.16% on average.

US equities returned an average of 8.35%. And a portfolio of non-American or British bonds would have returned 6.7% even once the 313 debt restructurings in 91 different countries over that time were taken into account. In simple terms, sovereign debt performed better than domestic debt, and earned comparable returns to equities. More recently, the deal has been even better. Between 1995 and 2016, global sovereign debt returned an average of 9.1%, US equities 7.3%, and US Treasuries just 3.2%. Again, even with defaults taken into account, sovereign debt outperformed.

Why sovereign debt is a good bet

There are two reasons. First, the markets turn out to be pretty good at pricing in risk. The interest charged for countries where there is a chance the money won’t be repaid may not be eye-watering, but it is enough to make up for the potential losses. Second, while there are often problems with sovereign debtors, outright defaults are very rare. Russia repudiated all its debts after he 1917 revolution, but that was the exception. In most cases, there is some form of restructuring. Overall, the losses only amounted to 1.3% of a typical portfolio, and in more recent times that has been getting better as well. Indeed, the only two defaults since 1990 to generate serious losses were Argentina in 2001 and Ecuador in 2008.

We read a lot about how Greece, Italy, Russia or Argentina won’t be able to roll over their debts, or might face imminent bankruptcy, or how investors will see crushing losses imposed on them. It is mostly noise. Investors have seen the numbers and the market, as so often, is being completely rational. Lending money to national governments, even when they are fairly ramshackle, is one of the best investments you can make.

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