What Level of Government Debt to GDP Ratio is Sustainable?

Question

I was reading that Japan has a debt to gdp ratio of 240pc and I cannot understand why this has not left the country "bankrupt"? From looking at this like an ordinary person this level would be completely unmanageable. Furthermore, considering Greece had problems with its national debt with a debt to gdp ratio of less than 200pc I am not sure how Japan has sustained significantly higher ratio for so long? Therefore my question is what makes a certain level of debt to gdp ratio sustainable? Also who does the government owe the debt to and does it matter who they borrow from? ie domestic vs international.

For interest see the following graph,

Answer 1

As you have pointed out: where it comes from is very important. As to the Japanese situation it is quiet different from the US position from example. In fact most of the Japanese debt is owned by Japanese people (90% of the current debt). More specifically the BoJ plays a big role as a buyer, and puts pressure on Japanese yield, which makes it cheaper for the government to issue bonds !

Another interesting point that is usually left by anlysts: Japan is the biggest creditor in the world. The country holds a net amount of about 3 trillion USD (367 trillion yen) of financial assets through the world, which makes Japan the first creditor worldwide (before China !).

An interesting further reading which gives other information on the Japanese debt under stress tests of the IMF (P.40): https://www.imf.org/external/pubs/ft/scr/2015/cr15197.pdf

You also might want to read this paper of Rogoff and Reinhart called "Growth in a time of debt": http://www.nber.org/papers/w15639 . It was really criticized but is a good first glimpse... Afterwards you might want to go a little bit deeper into the debt sustainability analysis of the IMF...

Edit

• The reference of Rogoff is more an introduction to the comprehension of debt dynamic than an argument for the existence of a threshold than would reduce growth. On the controversy of the paper, like pointed out by @dv_bn, you can check this intersting article: http://www.newyorker.com/news/john-cassidy/the-reinhart-and-rogoff-controversy-a-summing-up
• Thanks to @denesp: Whenever you see "first creditor" this usually takes public and private assets into account. However, if you want to analyze the public debt you should only take financial assets owned by the government (mostly T-Bills regarding Japan).
• I add also an interesting article I have read about it, which was written by economists from the NY FED, check it out: http://libertystreeteconomics.newyorkfed.org/2016/06/the-rapidly-changing-nature-of-japans-public-debt.html#.V2qJW2r2aM8

Answer 2

I don't think you can sensibly discuss this without including two additional factors:

• what is the prevailing interest rate?
• is the debt in local or foreign currency?

The first affects the cost of repayments. Interest rates are at record lows in the developed world. How much money is it reasonable to borrow at 0%? What about -0.1%, is there even a limit that could be sensibly applied to such a negative rate, when the more you borrow the more you will be paid to borrow it?

Secondly, debts in local currency, especially hard currencies like the dollar, yen and euro, are much less risky than debts in non-local currency which can be affected by exchange rate shifts.

Further, like with individuals, it's not sensible to assign a single level beyond which you should not go. It should be more of a process of credit scoring. The 'credit score' for governments is effectively the bond yield. During the European crisis of 2008+, bond yields went high. Today the Japanese bond yield is .. negative. Indicating that it's thought safer to lend your money to Japan than to hang on to it as cash or keep it anywhere else.

Where are the low rates coming from? People and organizations that are extremely wealthy have a problem. The world has run out of good-yielding investments and safe, high-interest debtors. There is literally no safer way of keeping a hundred billion dollars than lending it to a developed world government. Even if you have to pay them for a privilege. It's safer than keeping it in a bank that might go bust.

Answer 3

The key point is not the Debt/GDP ratio by itself but the sustainability of the debt over time. The government borrows money from the market and uses taxes to repay it, as households borrow money from banks and use their income to repay it. Before moving on, let's look at a simple debt accumulation equation

where b(t+1) is the debt/GDP ratio in period t+1. It depends in s, that is the primary surplus of the government, r, that is the real interest rate, and gamma, the growth rate of the economy. In Japan the debt/GDP ratio is high but they also have very low real interest rates and a primary surplus which allow them to repay the debt. On the contrary Greece, accumulated to much debt enjoying the low interest rates granted by the Euro. When the crisis hit, markets lost confidence on Greece's ability to pay back. Thus they sell off their bonds. Interest rates sky-rocketed and because of the economic crisis the growth felt down. Moreover, the government had, and still have, many problems in collecting taxes. Therefore, Greek debt is more unstable and dangerous than the Japanese one, even if it is lower both in relative and absolute terms. In a nutshell, default arises when you run out of money for repaying interests regardless of the amount of the outstanding debt. Nonetheless, Japan is in trouble. The more the debt growths, the more budget resources will be allocated to repay interests. Hence, forcing the government either to increase taxes or reduce spending in other areas, something that is politically difficult. Anyway I suggest you to watch this video, it gives a roughly idea of what is going on there Japan's Debt Problem Visualized

Regarding your question on domestic vs international creditors, they are important when the government wants to decide whether to default or not. The more debt is owned by resident the more costly is going to be to default as your citizens would bare the loss. And, in any case, the government has to pay back interest regardless of the nationality of the creditor.

Answer 4

There is a key factor determining a country's likelihood of default which has only become a research topic in the last decade or two: The quality of its government, in particular the prevalence of corruption. (Interestingly, the type of government -- democracy, autocracy -- is comparatively unimportant.)

Greece has a poor political system; cronyism and corruption are wide-spread. Japan's government, by contrast, works very well (although certainly conflicts of interest for example concerning the regulation of nuclear industry have come to light). So far Japan's creditors trust the country to repay; Greece's are not so sure.

Answer 5

Not much point in writing a lot about an equation that any sovereign debt analyst should know.

Sustainability definitely has to do with debt/gdp, the prevailing interest rate for sustaining that debt and the primary balance that the country can run.

The IMF has a nice enough preso on this: Fiscal and Debt Sustainability and I'd recommend going there before looking for other answers on this forum.

Answer 6

Explanation for kids

Japan is a middle-aged doctor who took out a second mortgage maybe they shouldn't have. They are still wealthy, and still have a great, high income job. So people will take more chances loaning them money, even if the debt is starting to pile up. If worse comes to worst, this doctor can always sell their vacation condo to make ends meet.

Greece is a car salesman, who lied on a bunch of credit card applications and lived in too large a house for a few years until it all caught up with them. Although they owe less than Japan, even as a ratio to their income, their job is much less stable, so the interest is higher and their creditors are much less patient. They also live in their parents' basement, so they have no house to sell to get them out of trouble. And most worrying, they haven't assumed responsibility for the mess they made! They spend most of their time blaming other people rather than trying to fix it.

Explanation for high school students

What matters is the ability to make money and repay the debt, not the size of the debt itself. Someone making \$200,000 a year can buy a million dollar house, which puts them into a lot of debt, but they can handle it.

Someone who tells the bank they are making \$70,000 a year but are really only making \$40,000 a year cannot afford a million dollar house. That's Japan v Greece, respectively.

Most of Japan's money is owed to itself, and in yen. So if the value of the yen falls, the debt is still basically the same. And it's Japanese citizens and Japanese banks that own most of the debt. Japan only has to answer to Japan. And Japan has enough money and is rich enough to pay off all its debt and to pay for what it needs. If the country needs more money, it can borrow it from the Japanese people and banks.

Greece had debts in Euro, and foreigners controlled its debts. The Greek economy went bad, and it was German and French banks that wanted money back. Greece couldn't pay its citizens or the debt, or borrow more money from its own citizens.

Of note the UK, after the Napoleonic Wars, had a debt to GDP ratio of over 250%. And it was almost 250% after WW2. It's not about the size of the debt, it's about the ability to make the payments. Japan is rich; Greece was poor.

And Goldman-Sachs cooked the books for Greece to make Greek more solvent and get Greece into the EU. Once Greece was in the EU, investors became more confident in Greece's financial strength because of their direct association with countries like France and Germany. It was kind of like having a joint credit card. This decreased the interest rate on Greek bonds and Greece went on a borrowing spree to appease voters with unsustainable social programs.

Example with some numbers

Japan owes most of its debt to its own people and at a quasi non-existing interest rate. It's like they owe 200,000 USD at 0.05%, and have an income of 100K a year, so they need to pay 100 bucks every year. Japan can afford that.

Greece owes most of its debt to outsiders and at a much higher interest rate. It's like they owe 5,000 USD at 10%, with a 5K a year income, so they must shelve 500 USD every year. That's already a much more significant amount.

Although Greece's debt is much smaller, it must pay five times what Japan has to pay. And don't forget that Japan's population is 12 times higher. This means, per person, Greeks must pay 60 times what Japanese do.

That's the reason why Japan is not in dire straits but Greece is: Japan owes money to itself, at 0% interest rate, while Greece owes money to the mafia at high interest rate.

In addition, Japan has so much excessive domestic savings that it is venturing into "ZIRP" (Zero Interest Rate Policy) and more recently slightly into "NIRP" (negative interest rate policy) territory. Japan's corporations and citizens have too much cash sitting idle. They'd rather lend it for free to their own government than rent safe-deposit boxes to store their cash.

Answer 7

I think a lot of people here gave some really good answers, including the person who got some downvotes.

240% debt-to-GDP ratio is based on a mathematical calculation. For example, currently here in the United States, we have a 105% debt-to-GDP ratio (\$22 Trillion ÷ \$21 Trillion = 1.05) That is the calculation used to arrive at that 240% you speak of.

Both are unmanageable debt-to-GDP ratios, the manageability consensus among economists being no higher than 60% debt-to-GDP ratio. So its not just unmanageable for individuals, it is indeed, unmanageable for nation-states as well, but if those figures concerning Japan are correct, why have they not entered insolvency is your burning question.

Well, remember that nation-states can sell their debt via the bonds that Alexis talked about in his answer. Human behavior is always at play here. It could be that wishful thinkers type of investors are still hopeful that Japanese policymakers will reverse course just as with U.S. Treasury holders. Additionally pointed out by Alexis, Japan is a creditor to the nation that holds the worlds reserve currency, so we have to ask ourselves, if Japan was allowed to go insolvent, what effect would it have on the nation-state who holds the worlds reserve currency? Is that a desirable outcome to the international monetary system?

The difference with an individual is, nobody really cares if you go bankrupt except your loved ones. No one has skin in the game with your finances except for you and your loved ones. With nation-states there can be a lot more at stake.

Also, much like the United States, Japan is a major world economy with credit-worthiness and can also borrow in a currency that it prints...the yen. If you could borrow money as an individual in a currency that you print, you see how you would not go bankrupt so easily despite a huge debt load?

Remember, its the interest and late fees that really do us in where we as individuals have to file for bankruptcy and we can't print more money, we have to work more hours or hit the lottery or an inheritance.

By the way, by my research, in 2017 the Japanese debt-to-GDP was more like 253%.

The good news is, if Japan can hold such a debt load, it does not seem that the United States will collapse at 105%. This does not mean all is well.

When a nation-states debt-to-GDP ratio goes above 90%, that nation has gone through the looking glass into a new world of negative marginal returns on debt, slow growth and eventual default through nonpayment, inflation or renegotiation. This day is sure to arrive for both Japan and the United States, so do not be frustrated that it has not happened, it just does not happen as quickly for a nation-state than in our own personal finances. More complexity involved, before that day comes it will be preceded by a long period of weak growth, stagnant wages, rising income inequality and social discord.

Here are a couple of resources that may also be of help to your inquiry:

https://www.bis.org/publ/work352.htm

Used wisely and in moderation, [debt] clearly improves welfare. But, when [debt] is used imprudently and in excess, the result can be disaster. For individual households and firms, overborrowing leads to bankruptcy and financial ruin. For a country, too much debt impairs the governments' ability to deliver essential services to its citizens.

https://voxeu.org/article/debt-and-growth-revisited

Have you researched whether that is already going on in Japan? See also this 2010 European Central Bank study. It says that "a higher public debt-to-GDP ratio is associated, on average, with lower long-term growth rates at debt levels above the range of 90-100% of GDP."

Notice this is not research from some fringe economics, it comes from the heart of the international monetary system and sponsored by the central banks.

So stay tuned, as evidence is accumulating that developed economies such as Japan and in particular, the United States, are on dangerous ground and possibly past the point of no return.

For example, despite not going bankrupt the last two decades for the Japanese economy has not been great, and I believe it could be possible that our next two decades here in the United States will look something like Japan's last two decades.

Answer 8

First understand the concept of debt to GDP ratio %. It means country's ability to repay it's debt. Means 240% means Japan has 2.4 times directly reserves to meet it's external debt. It is a good sign low % is a bad sign. Lower than 100% is a bad sign.

Answer 9

The current monetary/financial system is unsustainable. Exploding debt is the unavoidable outcome of a Global Debt Based Ponzi Scheme

Commercial banks create the money as debt. All money is debt. Only the principal is created, not the interest payments, so there is always more debt than money. No way to pay it back unless we end the real economy and all start working for the banks that create the money.

Fiat debt based monetary systems have a finite life span. On average it takes around 27 years before fiat money returns to intrinsic value zero.

The human race has a lot of experience with these type of monetary systems. I think there are around 227 cases documented, each time the result is the same.

This time we have tried it on a global scale. All currencies including the reserve currency dollar are fiat debt based.

However poor the results this is still the preferred system. It is preferred by the elites that own the sleep walking masses.

The negative rates are a clear sign that we are near the end of the current system. As the masses are still vast asleep it will be replaced by a similar system. This is the price of ignorance.

See the 1988 cover of the Rothschild publication The Economist. It show a Phoenix standing on burning money, predicting a new world currency in 2018.

It is the currency for global enslavement and it is still right on schedule.