Debt Rollover

When a household, corporation or government has an existing debt obligation, they’re expected to pay down the principal and accompanying interest. But far from every debt gets extinguished this way. Actually, most of them are paid off only thanks to taking on new debt. Call it robbing from tomorrow in order to pay for today, that’s what debt rollover is.

And in selected circumstances, it makes perfect economic sense. Debt is not a dirty word, and when used productively, it has benefits. In essence, the marginal productivity of debt is the metric that matters. If an additional unit of debt is able to generate enough income to service the obligation and still leave profits, taking on more debt is justified. And one way of getting more of it is not to pay the existing debt off and renegotiate its terms (size, maturity, interest) with the existing debt owner.

Some debt instruments even assume that the borrower would be making only interest payments while the principal remains in existence in perpetuity. 30-year Treasury bonds aren’t the debt instruments with the longest maturity, as several countries (yes, including Argentina) have issued 100-year bonds already. That comes pretty close to a perpetually rolled over debt, doesn’t it?

It sure sounds like debt rollover is no big deal. And most of the time, it really isn’t - as long as access to the debt markets on reasonable terms, remains intact. It’s only when there are doubts about the debtor’s ability to service the debt – then, the markets become squeamish about extending more loans. The bell tolls, so to say, and chicken come home to roost.

With suspect creditworthiness (credit rating), the costs of servicing existing debt may go up, and issuing more debt on the primary market becomes prohibitively expensive. Credit default swaps go through the roof as the bond vigilantes pull a plug, smelling blood. These are the building blocks of a financial crisis, or better yet a sovereign debt crisis. In such an environment, debt renegotiation, partial or complete forgiveness become options on the table, theoretically or practically.

Debt Rollover and Gold

Sometimes, the can just can’t be kicked down the road much further. As the European debt crisis of 2011 and the US debt downgrade in the summer of that year show, that’s a time when gold as a safe-haven asset does particularly well. Unlike debt, it’s no one’s responsibility, which means that it carries zero counterparty risk. And gold did enjoy its parabolic run to the 2011 in exactly this environment.