So exactly when does a lot of debt for a country such as the United States, Japan, the United Kingdom, Greece or Italy become too much debt?
The threshold is when government debt rises above 90% of national GDP, economists Carmen Reinhart and Kenneth Rogoff argue in a paper headed for publication in the American Economic Review. (You can read a draft of the paper at http://www.aeaweb.org/aea/conference/program/retrieve.php?pdfid=460 )
After looking at data from 44 countries spanning 200 hundred years, they’ve concluded that at ratios of debt to GDP up to 90% there’s not much correlation between government debt and economic growth. Above 90%, however, median economic growth rates fall by one percentage point and average economic growth rates fall by about four percentage points.
That makes the 90% level a kind of make-or-break point for countries that are hoping to grow their way out of debt. If the government debt load climbs above 90% of GDP, economic growth slows so much that growth is no longer a viable solution to reducing government debt. Above that 90% level, governments serious about reducing their debt load have to increasingly rely on “solutions” such as reducing wages and depreciating their currency that might over time increase global economic competitiveness enough to give a boost to national economic growth. In the short to medium term, however, these “solutions” inflict real pain on the citizens of the country since they reduce standards of living.
The scary thing about Reinhart and Rogoff’s conclusion is how close the United States and other major developed world economies are to the 90% cut off thanks to the global financial and economic crisis.
How close?
The United States finished 2009 with a debt to GDP ratio of 85% according to the International Monetary Fund (IMF). On current trend, the United States will finish 2010 at 94% and 2011 at 98%.
The United Kingdom was slightly further away from the cutoff when the International Monetary Fund last updated its numbers in October. At that point current trends saw the country finishing 2009 at a 69% debt ratio and ending 2011 at 89%. The economic and financial condition of the United Kingdom has deteriorated since then, however. The most recent figures show the country finishing 2009 at a debt to GDP ratio of 72% and breaking the 90% barrier in 2011. (For more on the U.K. financial crisis see my post https://jubakpicks.com/2010/01/08/the-next-financial-crisis-has-a-name-and-its-the-united-kingdom/ )
The two biggest continental economies are in surprisingly similar shape, according to the IMNF’s October calculations. France ended 2009 at a 77% debt to GDP ratio, according to the International Monetary Fund, and on current trend will hit an 87% ratio in 2011. Germany ended 2009 at 79% and will end 2011 at 88%.
Italy at 116% in 2009 and Japan at 219% in 2009 are already well beyond the 90% cut off where debt begins to depress national economic growth. The recent steps by the Democratic Party of Japan government to move to a weak yen policy would seem to mark recognition that there is no way to avoid “solutions” that reduce living standards in Japan. For more on this shift see my post https://jubakpicks.com/2010/01/07/is-japan-betting-its-future-on-a-new-weak-yen-policy/ )
Sorry to be such a bundle of gloom today but the clock is ticking on the debt problem. Loudly.
Full disclosure: I don’t own shares in any company mentioned in this post.
China’s debt/GDP: 15.7%.
Brazil: 40.7%.
India: 58.2%.
While all the developed world wallows in their out of control debt, the emerging markets, especially China, will be the place to have your money.
If history is any lesson this sort of reminds me of europe prior to WW 2 . All of the big countries had printed money and taken on debt to finance ther economy and the war . When it all ended they were bankrupt and infliation was out of control.It caused a massive upheavel of the populace and led to the downfall of numerous goverments and there financial system. Granted we have a more sophisticated financial system now, But what goes up must come down sooner than later. Out of control debt is proabaly worse than all out war on a economy.
In an earlier post, you suggested that emerging economies would show more robust growth than the U.S. and that these may be good markets to invest in. What are their GDP:Debt ratio?
Bole: Australia.
http://en.wikipedia.org/wiki/List_of_countries_by_public_debt
Jim,
Is there any good developed country to put our money in?
ok, so there’s all this supply of gvt debt out there, who’s going to buy it? High supply and low demand means lower prices on gvt debt and higher yields. I think most people see that coming. The question is whether the big debtors will start selling their gold reserves. Do they have enough gold to make a difference to their debt levels or to the price of gold?
History does not repeat itself. But the British pound lost its supremacy after a long agony, some wars and a final hit. Many investors lost money when the British decided to make their debt too cheap to pay (depreciating its currency relative to creditors’ currencies). That was the final hit. From there we know the decades of painful economics in Britain. The United States was then a major creditor and a source for inspiration. Then the American dollar took its right place in the world.
Now we are in the middle of two worlds that will demand much more money (up to 3 trillion according to Mr. Joseph Stiglitz). As you said eventually the United States will face that ugly truth. I don’t know what will be the final hit, but the long agony we see it everyday. Today the big creditors are others, and it might be that the developed world won’t be as developed as we believe it is. Yes, it is a gloom perspective.
One of Kenneth Rogoff’s colleagues, Niall Ferguson, also writes about this concern. In “An Empire at Risk,” at http://www.niallferguson.com , he speculates that one result of debt above 90% GDP could be a rise in real interest rates – a rise in treasury yields without a proportional increase in inflation – choking growth while making the debt near impossible to pay off.
Jim… I appreciate the “gloom”, it may not be what we want to hear, but we NEED to hear/read it. While the market seems to roll regardless of news or value (is the govt pumping it up?), I am very skeptical and am waiting for a drop. I am more into cash than I would prefer but I can’t find anything that calls out to me now and it seems like there are some very dark clouds on the horizon.