Daily chart: which countries have the biggest debts? Judged by its towering sovereign-debt burden and budget deficit, Japan should be a concern for investors. Yet there are good reasons why the euro-zone countries are first in the firing line.
There’s nothing technically wrong with this chart but it allows me to jump on one of my hobby horses.
The debt-to-GDP ratio in itself is meaningless. And it’s important to know that, because misunderstanding the debt-to-GDP ratio means you misunderstand a ridiculous basic concept that everyone should understand: the difference between a stock and a flow.
GDP is a flow. It’s (to grossly simplify) all the money that a country makes in a year. Debt is a stock. It’s, well, all the debt a government (not a country) has accumulated.
Why do people use debt-to-GDP? It actually makes sense to use it for comparisons between similar countries that have different GDPs. France, Britain and Germany have economies that are similar in many ways but also not the same size so if you want to compare their debt burdens it makes sense to talk of debt-to-GDP ratios instead of absolute numbers. (Which, again, is why this chart is technically fine; my problem is that people will draw way too many implications from it.)
But by itself, debt-to-GDP doesn’t mean anything. Nigeria has, if memory serves, a debt-to-GDP ratio around 20%. Does that mean it’s “healthier”? Well, given how good Nigeria has been at taxing its populations and how much interest it pays, it might not be able to sustain much more than 20% of GDP (or rather, payments of some % of GDP per year (flows), which under some assumptions you can say work out to some % of GDP of debt).
Conversely, given that Great Britain has never defaulted on its debt in the past four centuries, has an immensely wealthy and diversified economy and has a currency that global investors all like very much with a credible central bank, and so enjoys very low interest rates, it might be able to do just fine with a 200% debt-to-GDP ratio.
Or it might not! The point is that debt-to-GDP ratios are only useful for a very specific thing (international comparisons) and are instead the über-metric observers, including some experts, use to assess the sustainability of debt, when it’s not.
Pascal is right. Alan Blinder, I think, pointed out that GDP is a ratio with dollars in the numerator and time (one year, by convention) in the denominator. Why not go all the way? When comparing debt to GDP, do the fractional math and instead of talking about this ratio as a magical, unitless index, refer to how many “debt-months” different countries have. A 200% debt-to-GDP ratio, for example, would mean 24 debt-months. It would take 2 years to pay down the government debt if the country’s entire GDP were redirected into it. Is that any less silly?
