Woody Brock Explores the Debt Burden

By on May 23, 2009

John Mauldin recently featured a well-researched essay by Woody Brock, head of Strategic Economic Decisions, at his “Outside the Box” newsletter.

An excerpt:

There is nothing new about a nation running into trouble and running up large amounts of debt in bailing itself out. There is also nothing new about attempting to monetize (via “quantitative easing”) the resulting accumulation of debt. The good news for the US is that its total federal debt of some $10T at the outset of the crisis in 2008 was a manageable 70% of current GDP of $14T.2 Suppose debt rises $3T by the end of 2011 as the Congressional Budget Office now predicts, and then rises $7T more by 2020. The result will have been a doubling of federal debt between 2008 and 2020, rising from $10T to $20T.3 While this increase is shocking, some forecasts are much worse.

Suppose, moreover, that GDP rises conservatively to $17 trillion in 2020 from today’s $14T as a result of a modest 2% GDP growth recovery between 2011 and 2020. Then the federal Debt-to-GDP ratio would rise from today’s 0.7 to 1.18. Interestingly, this does not represent the disaster many observers assume. To begin with, there are nations where a disturbingly high Debt-to-GDP ratio proceeded to fall way back down over time. Thus, the US Debt-to-GDP ratio was 1.25 at the end of World War II, yet it fell to 0.25 by 1980. Britain’s Debt ratio upon defeating Napoleon in 1815 was over 2.7, and it fell back to 0.2 by the end of the 19th century.

In other cases, the Debt-to-GDP ratio has stayed persistently high, neither increasing nor decreasing dramatically over time. Thus Japan has had a very high ratio of 1.5 to 1.8 for the past decade. Italy and Belgium, too, have sustained high ratios in the range of 1 to 1.25. Finally, there are the countries where the Debt ratio continues to rise after some initial shock with either hyperinflation or outright default being the end result. Such has been the fate of myriad banana republics including some large players such as Brazil, Argentina and Russia. What exactly determines which nations dig their way out, or else go under? This will be our primary focus in the pages ahead.



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