Why The Level Of Public Debt Doesn’t Matter

I was asked a question on Twitter the other day on what level I thought government (public) debt was too much. My answer was that there was basically no line-in-the-sand level. It’s very hard to quantitatively find the level of debt in which it will start to matter. What do I mean by “matter”? Well, two things. Primarily, at what level will markets “get scared” and interest rates start to shoot up? Secondly, at which level will “monetizing the debt” start to cause inflation?

To me, these questions are very hard to answer; one that’s only able to be answered qualitatively. Of course, you can throw a very large number out there and probably be right. Debt to GDP at 10,000% would probably mean one or the other “matter” scenarios would occur. But what about 350%, 100%, 50%, 20%? To show you why the level does not matter when determining how high is too high (for public debt) , I will display a few charts below.

The Charts

Japan

Below you have Japan, whose Debt:GDP ratio is somewhere above 200%.

Debt - Japan

 

 

 

 

 

 

 

 

 

 

Yet, interest rates have stayed pretty much stayed super low. Below is the yield on the 10-year Japanese government bond. Besides a very short lived spike in the late 90s, the 10 year yield has really not seen above 2% since the mid-90s. In fact, despite the debt growing, interest rates keep falling. Will yields one day spike? Maybe. I don’t think you can say that for sure it will one day. I know a lot of widows have made that prediction and have gotten burned. But to say that it will happen for sure at a specific level is very wrong-headed.

 

Spain

Spain is pretty much the opposite of Japan. Their debt had been falling for years leading up to the Great Recession. After the great recession, it spiked, but only to levels seen before

Debt - Spain

 

 

 

 

 

 

 

 

 

 

You can see, debt was rising from the early 80s to the late 90s, but rates fell (albeit, very choppily). Rates stayed low when debt fell from the late 90s to the mid-2000s. However, in 2011/2012, Spain had a “debt crisis” as interest rates rose (although the levels were much lower than part of the 90s and 80s). However, the overall Debt:GDP level was pretty much at the levels it had been before the crisis.

As I said, its very hard to determine what level matters. 2011 Debt levels at the same level as mid-2000s, but rates were higher…2011 Debt level at higher levels (vs 80s/90s), but lower rates (when compared to the 80s/90s). Now, despite debt levels being at the highest on record, interest rates are falling again.

 

Italy

Italian Debt:GDP levels have been above 90% since the late 80s.

Debt - Italy

 

 

 

 

 

 

 

 

 

 

But interest rates have been kind of everywhere. We saw a major fall from 1995 to about 200, during a time when Debt:GDP fell. So that kind of makes intuitive sense. Rates stayed flat for the 2000s, however in 2011/2012 we saw rates “skyrocket” although the debt:GDP ratio was at levels it had seen before – when interest rates were much higher. Again, no pattern when/where rates fall/rise.

 

Australia

Australia’s debt fell very quickly in the 50s and has pretty much stayed low (chart is a little outdated, but right now, Debt:GDP is around 20%).

Debt - Aust

 

 

 

 

 

 

 

 

 

 

 

However, look at what happened to rates in the 70s and 80s. They skyrocketed despite Debt:GDP being very low and only marginally rising. Then they fell quickly in the 90s and 2000s despite the ratio only marginally falling.

 

United States

This brings me to the US. Many people fret over the total Debt:GDP ratio being at 100%. But should they? After all these examples, it’s really hard to make the case that you can determine what level rates will rise.

Here’s a chart of US public debt as a percent of GDP dating back to the 1780s. We’ve seen debt as low as 0% and debt as high as 112%. This chart does not include debt the government owes to itself.

Debt US

 

 

 

 

 

 

 

 

 

 

 

 

Here’s the same chart but including debt the US government owes to itself.

 

Debt US

 

 

 

 

 

 

 

 

 

 

 

 

 

Below is a historical chart of the 10-year US treasury yield dating back to the 1780s. You can see that despite having the highest levels of debt (as a percent of GDP), yields fell to their lowest levels ever, even in the same year. Rates bottomed then and rose until 1981 despite debt falling as a percentage of GDP.  Over the last few decades, we’ve seen debt rise (again, as a percentage of GDP) but yields fall to the low levels seen a half-century before.

And no, the $FED has not been the only buyer (although it is the “decider”).

Conclusion

It’s impossible to deduce anything from knowing the Debt:GDP (let alone just the nominal debt level). To say that once debt hits a level (90% anyone?), it will cause rates to spike or an economy to slow/crater.

So we should stop trying and halt any debate when it comes to this. We need to qualitatively analyze the situation and determine from there. Does the country borrow in it’s own currency (does it not)? Is there structural issues within the country? Is there inflationary pressures, and if so, how? So we basically need to go further than just the Debt:GDP ratio.

(No, just because I say the level doesn’t matter doesn’t mean debt doesn’t matter. And no, government debt isn’t always bad!)

 

Tags: $FED $ECB $MACRO $EWI $EWP $EWJ $TLT 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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