Countries Overloaded With Debt

The US National debt is staggering: $11.896 trillion. There are widespread calls inside and outside the United States to reduce the country's debt, fueled by fears ranging from the rising tide of inflation to the possibility that the dollar will lose its privileged position as the world's reserve currency.

But how bad is it, really?

There is no doubt that the US national debt is in dire straits and getting increasingly out of control; ballooning over 100% since 2000, when it was a mere $5.75 trillion. But despite steadily increasing debt levels, individuals and countries around the world continue to maintain a high demand for US debt, hinging their confidence on the strength of the American taxpayers and government revenues generated by the country's economic activity.

On a surface level it may seem like the United States' debt position, the biggest in the world, is also the worst. But when the numbers are looked at on a more relative basis, the total amount of debt owed by the US, although still quite high, seems more reasonable than that of other nations... at least for now.

One way to look at a nation's debt situation is by comparing external debt - the combined total of liabilities, plus interest, that corporations, private citizens and the government owe to entities outside their borders - to that country's GDP, a comparison called the debt-to-GDP ratio. By comparing what a country owes to what it produces, a picture forms of how likely or unlikely a country as a whole will be to pay back its debt.

"External debt is more worrisome and important than public debt, as public debt is generally recycled back into the economy," says Josh Bivens, Economist at the Economic Policy Institute who has studied the long-term trends of national debt positions. "With US government debt, a majority of interest payments go to US citizens and money stays within the country. External debt represents pure 'leakage' out of the United States and is money that citizens will not have because they've borrowed it in the past."

"External debt creates a much bigger hole than public debt," he adds, "for public debt it is hard to say which generation is being particularly harmed... but for external debt, it is pretty clear cut; you're giving away future income to support today's standard of living. You can't really say that about public debt."

But who should be concerned? Residents of the country, first and foremost, says Bivens. A massive external debt could possibly trigger an exchange rate devaluation, especially if a country relies heavily on imports, creating a situation where money will be more difficult to tax in the future, debts will be more difficult to repay with less valuable currency and issues of fiscal sustainability arise.

However, there is really no single "danger" level for having too much external debt as a percentage of GDP, and this depends much more on the country's economic context. If a country has seen a rise in its debt compared to GDP during a good economic expansion, this means something is really wrong and policies will have to change, Bivens says.

Out of the world's 75 largest economies, the United States has the 20th largest as debt-to-GDP ratio, standing at 94.3%, with a gross external debt of $13.454 trillion and an annual GDP $14.26 trillion. In fact, out of the largest 75 economies, this number is just above the worldwide average of 90.8% Western-European and North American countries dominate the upper end of the spectrum, with Switzerland (422%) and the United Kingdom (408%) at the #2 and #3 spots, respectively, and Ireland representing the most drastic debt-to-GDP ratio. According to the most recent World Bank data, Ireland's number stands at a staggering 1,267%.

So, relatively, the United States' debt isn't all that bad.

The current analysis was limited to the 75 largest economies in order to dismiss outliers existing simply due to their size, as small countries like Monaco or Luxembourg have disproportionate debt-to-GDP ratios of 1,850% and 4,910% respectively.

The first time this analysis was published on CNBC.com, it stirred angst from Ireland over the numbers, as the country was a significant outlier in the final data. A further breakdown of the country's external debt data, provided by the World Bank, shows that a significant proportion of the country's external debt is represented by the country's banking sector, accounting for approximately $976.48 billion. The argument is that the country's International Financial Services Center (IFSC) "lends almost nothing to the domestic Irish economy," according to the Irish Sunday Tribune.

However, to get a true apples-to-apples comparison, data from the World Bank as well as external debt estimates by the US Government were used, numbers which take into account this lending facility and any given country's banking system as components of the overall debt number.

With the Irish government itself forecasting a contraction in GDP of 8.3%, the debt-to-GDP ratio will likely continue to increase, even without additional foreign investment. The biggest difference in these numbers, however, is that the Irish taxpayers are only responsible (directly or indirectly, as in most countries) for a portion of the debt responsibilities. But even if the banking sector is removed from the total external debt number, Ireland would still have a 748% debt-to-GDP ratio, keeping the country at the top spot.

Take into consideration another nation with a troubled debt-to-GDP ratio: Iceland. According to the country's central bank, Iceland's external debt was measured at $104.44 billion in Q2 2009. With a GDP of $10.46 billion, that's a debt-to-GDP ratio of 998.5%. The Icelandic economy was the hardest hit out of any in the financial crisis, and although the country's external debt was not solely to blame, it had a major hand in the country's downward economic spiral, and when combined with a dramatic drop in the value of its currency, resulted in a near-government bankruptcy.

In comparison, notable countries which have extremely low debt-to-GDP ratios are Brazil (13%), Singapore (10.7%), China (4.7%) and India (4.6%), with the lowest ratio boasted by Algeria, at 1.2%. Too low a ratio may not necessarily be a good thing either, and could reflect a combination of lacked foreign investment, low confidence in the nation's finances or the absence of debt-funded growth and investment policies by the national government. Bivens points out that the tendency for emerging market economies to have low external debt levels is counter-intuitive, as these are the places where marginal investment is high, you should see net lending from rich countries to poor countries, not the other way around.

Although the perspective of debt-to-GDP can be a revealing way to understand the sustainability of a country's debt position, the future of a country's external debt relies on both domestic economic policy and the ability of an economy to attract foreign investments. The debate continues over whether there exists a realistic way to pay off these rapidly increasing levels of government and private debt, but one thing is clear: if we have learned anything from the global economic crisis, the policy of taking on excessive debt cannot be perpetually sustained, no matter the size of a debtor nation's domestic economy.

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