Debt Brinksmanship

Government debt as a percentage of GDP

1 Zimbabwe 282.6
2 Japan 192.9
3 Saint Kitts and Nevis 185
4 Lebanon 154.8
5 Jamaica 124.4
6 Italy 115.8
7 Iceland 113.9
8 Greece 113.4
9 Singapore 110
10 Sudan 105.1
11 Belgium 101
12 Sri Lanka 85.8
13 Dominica 85
14 Canada 82.5
15 Egypt 80.9
16 Hungary 78
17 Israel 77.7
18 France 77.6
19 Portugal 76.8
20 Germany 73.2
21 Malta 69
22 United Kingdom 68.2
23 Cote d'Ivoire 66.5
24 Austria 66.4
25 Ireland 64.8
26 Jordan 64.7
27 Nicaragua 63
28 Mauritius 62.4
29 Netherlands 60.9
30 Uruguay 60
31 Brazil 59.5
32 Seychelles 58.7
33 Albania 58.1
34 Bhutan 57.8
35 India 57.3
36 Philippines 57.3
37 Morocco 56.9
38 Cyprus 56.2
39 World 56
40 Ghana 55.2
41 United States 53.5
42 Malaysia 53.3
43 Spain 53.2
44 Vietnam 52.4
45 El Salvador 52.3
46 Norway 49.8
47 Pakistan 49.3
48 United Arab Emirates 48.9
49 Argentina 48.6
50 Tunisia 47.1
51 Croatia 46.4
52 Poland 46.4
53 Aruba 46.3
54 Turkey 46.3
55 Kenya 46.3
56 Colombia 45.3
57 Thailand 44.9
58 Malawi 44.6
59 Panama 44.6
60 Bosnia and Herzegovina 44
61 Costa Rica 42
62 Sweden 41.6
63 Denmark 41.5
64 Dominican Republic 40.8
65 Switzerland 40.5
66 Bolivia 40.3
67 Finland 40.3
68 Bangladesh 39.7
69 Mexico 39.1
70 Bahrain 38.5
71 Montenegro 38
72 Hong Kong 37.4
73 Yemen 36.7
74 Latvia 36.6
75 Slovakia 35.7
76 Ethiopia 35.4
77 Cuba 34.7
78 Czech Republic 34
79 Mozambique 33.4
80 Taiwan 33
81 Macedonia 32.4
82 Serbia 31.3
83 Slovenia 31.3
84 Ukraine 30
85 Papua New Guinea 29.7
86 South Africa 29.7
87 Senegal 29.6
88 Lithuania 29.5
89 Trinidad and Tobago 29
90 Syria 28.1
91 Guatemala 27.9
92 Gabon 27.6
93 Indonesia 27.4
94 Zambia 25.9
95 Moldova 25.7
96 Honduras 25.2
97 Peru 25
98 Paraguay 24
99 Romania 24
100 Korea, South 23.5
101 Saudi Arabia 22.6
102 New Zealand 22.2
103 Australia 22.1
104 Angola 21.7
105 Tanzania 21.4
106 Uganda 20.2
107 Algeria 20
108 Ecuador 19.7
109 Botswana 18.6
110 Venezuela 18
111 China 16.9
112 Iran 16.8
113 Cameroon 16.3
114 Gibraltar 15.5
115 Namibia 15.1
116 Bulgaria 14.8
117 Luxembourg 14.6
118 Kazakhstan 14.2
119 Qatar 14
120 Kuwait 13.1
121 Nigeria 11.8
122 Uzbekistan 9.6
123 Russia 8.3
124 Estonia 7.1
125 Azerbaijan 6.7
126 Chile 6.1
127 Wallis and Futuna 5.6
128 Oman 5.5
129 Equatorial Guinea 5.4
130 Libya 3.9
CIA World Factbook
(as of 2009)

Presidents Bush and Obama both said the only way out of the financial crisis we have is to take on more debt to stimulate the economy. Indeed, when the economy enters a recession debt will increase unless governments increase taxes dramatically. This is because when the economy slows down, profits and income reduce so tax revenue goes down. Meanwhile, spending for unemployment insurance and various welfare programs goes up.

So, they were both were correct. Certainly, we had to save our banking system. No matter how badly we wanted to punish the idiots who caused the mess, without a banking system no one gets a loan, no one can buy or lease a car, no one can finance a home, etc. Prices will head to virtually zero for everything because the US society is a society of debtors, not savers. When no one can get a loan, no one can buy much of anything (see my previous essay on the Banking System).

Beyond that, things get murky. Do we need any additional stimulus? Both Republican and Democratic leaders felt we did. Do we stimulate by increasing the money consumers have to spend in the hopes of increasing consumption or do we give tax breaks to corporations and the wealthy in the hopes that they will create new jobs with the windfall? The former is the general Democratic remedy, while the latter tends to be the Republican view. Again, this was discussed in a previous essay on Stimulus Packages.

A recent Stratfor article, Europe: The New Plan, got me thinking. Europe is in much worse shape than the US on a number of fronts. The EU has already bailed out Greece and Ireland and faces challenges in several more countries. Should Italy join the list, it is doubtful the European Union will survive -- at least not in anything resembling its current form. Basically, there isn't enough potential tax revenue within the EU to service the potential debt and continue to provide basic services. That is the tipping point. Once a nation has accumulated enough debt, it can no longer provide economic stimulation to the economy. It has to suck money out of the economy to pay for servicing the debt.

At this point, the dynamic factors that lead to economic growth reverse. Reduced profits and employment causes reduced taxation. Reduced income to the government faced with mounting debt causes even higher taxes. Increasing taxes slow the economy more, continuing the death spiral. Few remember that the maximum tax rate in the US was 91% until 1963, more than 15 years after the end of World War II.

For an illustration of what happens when debt causes the economy to shrink, we need look no further than Japan in 1990. Up until then pundits had been talking about the Japanese economy becoming the world's largest. The relatively minor worldwide 1990 recession dropped Japan into a far worse depression than the US suffered in the 1930's. It may not have been quite as deep, but it has lasted so much longer that an entire generation of workers has never known prosperity. On January 1, 1990, the NIKKEI Dow 225 was flirting with 40,000 after two decades of enormous growth.

Unfortunately, Japan's banks had bankrolled Japan's corporations to fuel the boom. A relatively small worldwide recession caused the banking system to turn upside down. After the government took over the banking system debt, things were bleak. Here we are, 20 years after the economic peak in Japan and the NIKKEI Dow is a quarter of what it was 20 years ago and Japan's debt ratio is still nearly double what Greece's is today. Property values are a fraction of what they were a generation ago and the Japanese population is aging alarmingly. As the post-war baby boomers retire, who is going to foot their retirement bill? Japan has the oldest population on earth. Their depression could easily last another 30 years.

Ireland and Spain are looking at the same kind of problems as Japan had, only they might have a "big brother" to bail them out. Unlike Greece who lowered the retirement age to 55 and spent lavishly on public programs to essentially bribe voters into voting the profligate into office continuously, Ireland and Spain had manageable public debts by modern standards, but their boiling domestic economies required massive funding and when the banks failed, the government had to step in. Ireland has been given a relief package, but some think it way too little. Spain will probably need one, too, and its economy is considerably larger than Ireland's. Essentially, Germany is the only EU economy with the ability to provide aid. And even for Germany, that's going to be doubly difficult: It's a lot of debt and it isn't popular with voters. If Spain and Italy were to need a bailout and Germany were to protect the EU by bailing them out, all of the EU would be looking at the same problems Japan faced in 1990. Politicians rarely enact policies they know will cost them their jobs. But the alternative means the end of the EU in anything like its current form.

Which leads us to the US. We can handle the current debt and probably the projected debt. But we are increasingly using up our wiggle room. If European economies dissolve into recession, Japan remains in the doldrums and China continues to undervalue its currency to retard imports, we will have no one to sell to. And everyone will be looking to sell to us as the only viable market. In that scenario, unemployment will remain extremely high as our exporting industries shrink and the social programs to pay for unemployment and the fallout from no exports will be added onto our current burden. We could easily lose our wiggle room -- and our domestic economic growth. In such a scenario, all the developed economies of the world would head into a depression much like Japan's of the past 20 years. And it won't last for only 20 years. It will take generations for it to heal. There are too many in the industrial world who will be retiring in the next 20 years and too few workers to pay for their retirement benefits. Even if every government wipes out its retirement systems and says we have to work until we die, the problem won't go away unless we also say that we will cut off medical aid when it gets too expensive. The welfare states of Europe will disappear. Benefits will shrink dramatically everywhere. There simply will not be a large enough tax base to provide the income for the governments to tax to pay for anything like what we have become used to. Any mass repudiation of the debt would doom the banking industry. A government could escape the debt this way, but there won't be a modern economy left inside the nation.

The press has been showing lots of scenes of Greeks rioting because of the cuts. Those cuts will be tiny in comparison to what will be necessary for all of the developed nations. What that means for the social fabric of "Western Civilization" is anyone's guess. But it won't be pretty.

But none of this will probably happen. In all probability Europe won't come completely unglued and we will all recover -- very slowly. That's the good news.

But unless all the developed governments get moving on reducing debt, the developed world will explode come the next "minor" recession. Thank goodness the United Kingdom has started to make cuts that aren't strictly necessary to escape the current mess. That's a good sign. Hopefully, the "I want my benefits and I want them now" crowd don't vote them out of office and install toadies who will comply with their short-sighted wishes.

In the US, we haven't really decided what we will do. The 2010 elections make it appear that we might be voting in favor of governmental restraint, but whether that will translate into a lasting movement is an open question. Certainly, it hasn't begun to penetrate the population clusters on the coasts. In particular, the retirement benefits of public employees in California guarantees that the state will go broke in the not-too-distant future. Why anyone would loan them money today is a mystery. I'd rather loan money to Greece.

December 27, 2010