Debt Apocalypse Now!!

I was taken a bit aback by Kevin Carmichael’s piece on Obama’s budget plans in today’s ROB. In what is more a news than an opinion piece on  concerns regarding fiscal sustainability in the US , he baldly states without attribution that

“Research and history suggests that a debt-to-GDP ratio of 60 per cent or higher is a prelude for default.”

Really? Who says that?

He appears to be referring to net public debt, which is currently 74% of GDP in the US and averages 62% in OECD as well as Euro area countries. (OECD projections for 2011.)  Japan’s net public debt is 120% of GDP. Even virtuous Germany has a net public debt of 52% of GDP.

The IMF and the OECD have recently issued reports suggesting that it would be desirable to bring advanced country debt gradually down to the 60% of GDP level given that it is headed higher in the context of aging societies, but I am unaware of any mainstream view that 60% is “a prelude for default.”


  • I do not get the remarks. No country nominally will ever have to defualt. However in using extreme countries like Wimar Germany, or Zimbabwe would have been better off in default, and letting the creditors take a loss.

    I’m not to concerned about Japan debt to gdp ratio at 120%, due to its debt being majority held by the Japanese Citezens. They used their savings collectivly, to purchase the debt. They also have a very large export sector compared to imports which due to an age old experession “like a sponge, soaks up” yen on global basis.

    The US is a joke. The Federal reserve has eclisped China as the singest biggest holder of there debt. A recent treasury auction that got little attention, “The $24 billion 10-year…drew an indirect bid, which includes foreign central banks, of 71%, a record since the Treasury Department began releasing auction data in 2003” I wonder if indirect bidders, will be there for every year in a increasingly polarized geopoloitical enviroment.

    Looking at the Obama plan to reduce the budjet over 10 years by 1.1 trillion dollars.

    Looking at GDP, the Obama admin. assumes it will grow by 3.22% every year for the next 10 years which does wonderous effects for unemployment later. In perspective it doesnt match the historical rate of growth in US GDP, nor if you take 1998-2007, for those 10 years the GDP grew by an average of 2.17%.

    Obama assumes for the next 10 years they will see about a 30% – 40% faster then decade that that 1998-2007. I would it expect it to be the same; flat, or less given the growing inequality, and other headwinds.

    The average unemployment rate for those 10 years assumed is 5.93%. This is important because they are expecting rolls of unemployed to enter the workforce, which increases the tax base, and also assumes in an oderly decrease in need of benefits to the unemployed. To get that avaraged rate it either assumes in the first half or latter of those 10 years, that unemployment will stay sustained at high 4% for at least 3 years. While inflations remains subdued, and interest rates stable

    Then comparing the plan released by Obama, to the plan released by debt commission enacted by Obama, both plans act over 10 years, while one reduces the deficit greater over the longer term.

    I think it safe to say the plan it not serious.

    Not extending any bush tax cut yields about 3 trillion, but Obama admin will not commit to higher taxes, for increased spending.

    Lookink at the last bipartisan deal of tax cuts with no offsetting spending cuts. You cannot have low taxes at current rates, while spending at these levels which could grow to an extent not seen since WW2.

    “During World War II, Keynes argued in How to Pay for the War, published in 1940, that the war effort [increased spending at such levels] should be largely financed by higher taxation and especially by compulsory saving (essentially workers loaning money to the government), rather than deficit spending, in order to avoid inflation.”

    I feel this is extremly relevant to any discussion of the US concerning if they should increase borrowing to keep lower taxes while increasing spending, or cutting spending to match tax rates the americans want, or raise taxes to the level of spending the american people want.

    “John Maynard Keynes described the situation in The Economic Consequences of the Peace: “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.””

    PS. Default, I still think is the better choice where the creditors take a real loss. In the case of Greece. I’m not a fan of increasing taxes, cutting services to pay the interest payments.

  • Kevin Carmichael’s 60% is from an article written by Reinhart and Rogoff in an NBER working paper last year regarding debt. For emerging markets they concluded: ‘external debt (public and private)—which is usually denominated in a foreign currency. When external debt reaches 60 percent of GDP, annual growth declines by about two percent; for higher levels, growth rates are roughly cut in half.’ The article got a fair bit of play amongst deficit terrorists. Apparently Mr. Carmichael believes the US is an emerging market.

    R&R also claimed a 90% debt to gdp ratio is problematic for developed countries: ‘ the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.’ Nonsense of course for any country that has debt in its own free floating currency.

    Unfortunately Mr. Carmichael (and Reinhart and Rogoff) does not understand monetary operations. He conflates the situation of the United States, a country sovereign in its own free floating currency that cannot default (like Canada, the UK, Japan, etc), with that of European countries that do not control their own currencies and can indeed default.

    His reference to Japan’s credit rating was especially amusing. He notes ominously that :’As Japan deals with the fallout of having its credit rating lowered…’ Apparently he is unaware that Japan was downgraded to below the level of Botswana in June 2002 by Moody’s. There were no consequences at all since Japan can always make any payment in Japanese yen it needs to and presents zero risk of default in its own currency. Interest rates didn’t rise there either because deficit spending tends to push short term interest rates down to the floor rate set by the central bank. Long term interest rates could rise somewhat but central bank actions greatly influence those as well. Whatever. This reality doesn’t stop irrational fear that bond vigilantes will suddenly push interest rates to some astronomical level.

    By the way, Moody’s is the same company that graded garbage derivatives as triple A in the lead-up to the financial crisis.

  • Japan bond vigilantee are rubbish. Japanese citizens own the their debt.

    I do not get where some progressives, do not see the risks from the US administration, the US congress, & the US senate; that will have taxes low, that will not be close to matching the spending, which could grow too levels not seen since WW2!

    I’m a conservative, who has always agreed with progressives tax rates should be increased to match spending in this country. The question has always been what should be the volume of spending to set the right level of taxes? Lest us ignore conservatives who demand lower taxes, & demand spending for a greater amount of government goods/services, thats speaks of hypocrisy.

    The US is not Canada – that should be also painfully clear. Keynes pointed vigorously “The inflationism of the currency systems of… various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”

  • Given the environmental calamity that is lurking around the next couple decades, makes me wonder how it is we could ever afford to get there with this kind of thinking.

    the other way, at least from a resource perspective, without some kind of economic revolution to meet these challenges is a globalized Keynesian renewal. We won’t get there with this short sighted scare mongering.

    Why can’t we borrow from the future in a manner that is sustainable socially and ecologically.

  • I think you are right that 60% is not really considered a prelude to default. I think the 60% figure was popularized by the European growth and stability pact.

    So higher than 60% is considered a concern, but not necessarily catastrophic.

  • For Brandon, Feb 16, @ 2:11 –
    I’m afraid I’m not sure what your point is specifically with regards to the US. You believe US government spending is too high compared to taxes. Why is that the case and what consequences do you foresee?

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