Tuesday, March 16, 2010

National Debt Ceiling

What is the maximum that a government can borrow? What is the maximum debt ceiling at which markets will stop lending. It is certainly a crucial question for governments, especially at the moment.

For example, why are markets currently very worried over UK national debt (at 60% of GDP) and yet seemingly ignoring the size of Japanese national debt (at 190%)

If national debt is so damaging, why have so many economies survived periods of government borrowing which exceeded 250% of GDP?

One thing is clear, there is no single point at which debt levels become unsustainable. You can choose an arbitrary figure like 60% of GDP, 100% of GDP or even 200% of GDP, but each case is different. Alot depends on the feelings of markets and investor sentiment.

What Factors Enable Governments to Borrow Over 200% of GDP

  • Domestic Consumers willing to buy government Debt. If the private sector has a high savings rate and a high willingness to buy government bonds this is a very beneficial for government borrowing. Often the highest debt levels occur in war time. But, patriotic fervour encourages people to buy bonds - out of patriotic loyalty. - You won't get many British people buying debt out of 'patriotic loyalty' in 2010
  • National Debt and Annual Budget Deficits. - It is important to distinguish between total debt and annual borrowing. One reason, the UK situation is difficult, is because of the rapid deterioration in public finances. Though total debt as a % of GDP is relatively low (60%). Annual borrowing is close to 12% of GDP. This worries markets as it indicates a rapid deterioration. It means the government have to raise a lot of funds in the short term.
  • Debt Maturity. - Government sell debt through selling bonds. These can be long dated (e.g. 30 years) or short term. Short term debt, means they will have to resell bonds / gilts more frequently. For example, the average UK debt maturity is 17 years. This is good because we need less frequent debt resale than say Greece which has a much lower debt maturity.
  • Past Record - A government like Japan has a good track record in maintaining low inflation, strong Yen and debt repayment. This good track record reassures investors that there debt is safe. If you compare to a country like Greece and Argentina - they have varying degrees of debt default, therefore it is much harder to convince investors there won't be a repeat.
  • Confidence - The importance of expectations and confidence is hard to underestimate. If people lose confidence it creates a negative spiral. Lack of confidence in a government's position leads to"
  • Foreign sell off - weakening currency - further discouraging investors from holding debt.
  • Raising credit rating, making borrowing more expensive.
  • It is this indefinable 'confidence indicator' which makes it so difficult to say what the debt ceiling will be.

If markets have unshakeable confidence then the limit on government borrowing may be very high.

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