The Global Debt Update

I was reading another depressing article about Europe’s debt the other day (this one was about Italy) when I realized that I had not published my perspective of the sovereign debt situation.  Many folks think that a country’s sovereign debt problems should be gauged by the sheer amount of money they owe.  However, a simple analysis of Italy ($2 trillion) and the United States ($10+ trillion) (not to mention Greece’s debt is less than Italy’s) shows that the debt problems associated with a country are not related merely to how much is owed.  I believe the two largest indicators are debt as a percentage of GDP and investor demand for debt.

DEBT TO GDP: AN ANALYSIS

GDP is the output or amount a country produces and represents one of the broadest measures of a country’s economic health.  It is therefore fair to measure a country’s default risk by determining what percentage of their output is needed to cover their debt.  Historically, countries that approach 100% debt to GDP (meaning their debt equals their GDP) have had sovereign debt problems.  Some notable countries and their debt to GDP ratios were as of 2009:

Country	Debt % of GDP
Japan	189.3%
Italy	115.2%
Greece	113.4%
Iceland	107.6%
Israel	78.4%
Hungary	78%
France	77.5%
Portugal	76.9%
Canada	75.4%
Germany	72.1%
United Kingdom	68.1%
Brazil	60%
India	58%
Spain	53.2%
United States	52.9%

Based on these numbers, we should be in a panic about Japan and Italy.  But why then were we in a panic about Greece, Iceland, and Spain first?  Why, as well, are we talking about the debt situation in the U.S. which is at 52.9% and below the global average of 56%?  The reason that these things have not happened yet is because of the second force behind sovereign debt, market demand.

MARKET DEMAND FOR DEBT

With equity markets around the world suffering, investors have turned to purchasing debt, which provides a usually guarantee return on investment.  The reason why Japan at nearly twice the debt over GDP has not been zeroed in on yet, is because so much Japanese debt is purchased by the citizenry.  Japan (until recently) had an extremely healthy savings rate amongst its population.  This savings was converted into purchases of government debt.  This is the only reason that their economy survived its failed spending spree after the recession of 1990.

Based on this analysis, however, Japan’s day in the debt spotlight is coming.  Other countries (like Spain) are seeing problems because investors are looking down the road and seeing massive amounts of debt to be issued either through friendly unemployment compensation (20% are unemployed and growing) or growing pension problems.

In the United States, we can take the Obama administration’s debt projections through the middle of the decade and use a 2.5% annual GDP (which is a higher than expected figure) to determine where the debt to GDP ratio for the United States is heading.

This chart assumes no recession between now and 2016, however, let’s assume that we have a mild recession in 2014 with a decent rebound in 2015 and NO increase in government spending as a result, along with 3% growth this year (instead of 4%) and 2% growth in growth years up to 2013 (instead of 2.5%).

  
These numbers all assume a better than expected recovery, a mild recession with no government “stimulus,” and that the government will meet the massive increases in revenue it projects.  In looking at these numbers, it’s obvious that on a debt to GDP basis, things are not looking well.  However, from the prospect of market demand, we have to ask ourselves, whose going to finance/buy all this new debt?  I never thought the Europeans would get the message before the Americans via “austerity,” but that appears to be the case.  The only thing that can stop this debt madness is a voting booth.