Naive Thinking About Sovereign Risk

It’s nice to see people wake up to the issue of credit and sovereign risk, something I’ve been writing about here for years. There is, however, a discussion variant over-focused on naive ratios and hand-wringing about large absolute numbers that is somewhere between mostly and entirely unhelpful. 

For example, there is more to sovereign risk than merely worrying about debt/gdp ratios. Small such ratios can you into big trouble if your external debt is denominated in another currency, while large such ratios can be relatively little concern if your debt is largely in your currency. There are many other factors too, like a floating currency, independence of central bank, political flexibility, reserve currency status, entitlement programs, government guarantees of non-public debt, etc.
The folks at CreditSuisse have created a new figure making this point by re-ranking sovereigns according to credit risk based on this multifactor model. The upshot is that China, Germany, Switzerland, the U.S., Australia, Japan, and Canada lead the way in terms of least sovereign credit risk. Agree or disagree with the absolute levels from the model, the point stands that naive models of sovereign risk are mostly fodder for idiotic headline writers, not helpful standalone measures for assessing real risk.