Monday, December 07, 2009

NYT Economix blog: How much national debt is too much?

Catherine Rampell of the NYT Economix blog examines the question of how much national debt is too much. The bottom line is, given the United States financial strength and its history of actually repaying its debt (unlike some emerging markets countries), the US still has some leeway. Of course, that does not mean the US can afford to be careless:

My colleague Graham Bowley and I have an article today about which countries — besides Dubai — are considered vulnerable to debt problems in the near future. Latvia and Greece, for example, are two countries that economic analysts say may be at risk for default in the coming years.

How can you tell which countries are really in trouble?

You might look to the country’s ratio of government debt to gross domestic product, one significant indicator for vulnerability to default that Graham and I mentioned in the article.

In Latvia, for example, general government debt is expected to reach 48.6 percent of gross domestic product next year, according to recent projections from Moody’s Investors Service.

But compared to some other countries, that number doesn’t look so bad. I’ve embedded below a selection of other high- and middle-income countries that Moody’s sent us. Click the plus sign to zoom in. [Editor: the plugin is on the NYT site itself.]

In the United States, general government debt will reach an expected 99.3 percent of G.D.P. in 2010. In Japan, the comparable number is a whopping 223.4 percent. And yet you don’t hear about too many investors fretting about whether either of these two countries will collapse tomorrow.

So why the double standard?

Carmen M. Reinhart and Kenneth S. Rogoff’s new book “ This Time Is Different,” which chronicles 800 years of financial crises, provides some context. Their second chapter, titled “Debt Intolerance,” shows that historically, the thresholds for default are much lower for many emerging markets.

Default has often occurred in countries that had debt-to-G.D.P. levels well below the 60 percent ceiling imposed by Europe’s Maastricht Treaty, which was intended to protect the euro from government defaults.

There are multiple explanations for why emerging markets are likely to default at lower levels of debt than more developed countries are. For one, emerging markets are more likely to borrow in a currency other than their own. That means they can’t use inflation as a tool to devalue their debt levels if they run into trouble, and so are more likely to get out of debt problems by restructuring their debt or defaulting outright.

Professors Reinhart and Rogoff also found that — just as you would judge a friend’s creditworthiness based on his history of deadbeat-ness — with countries, default history matters a lot. On page 30 they write:

[O]nce a country slips into being a serial defaulter, it retains a high and persistent level of debt intolerance. Countries can and do graduate, but the process is seldom fast or easy. Absent the pull of an outside political anchor (e.g., the European Union for countries like Greece or Portugal), recovery may take decades or even centuries.

So how much debt is too much debt? The magic number varies by country, based on a whole host of factors including the strength of a country’s institutional structures (can politicians make the hard decisions on where to cut spending and how to raise revenue?) and its prior track record on debt repayment.

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