Not surprisingly, in general, the countries with the highest levels of debt compared to their country’s economy wind up in the most financially vulnerable positions. In the case of Greece, for instance, the debt-to-GDP (Gross Domestic Product) ratio is currently estimated at about 163%. That is, the amount of government debt (not including corporate or individual debt) is 163% of the level of the yearly output of the economy. This debt-to-GDP ratio is so often used we usually take it for granted that this ratio is directly comparable across countries, and accurate, but the calculation of a country’s outstanding debt is often less than straightforward.
However, even looking at the amount of U.S. government debt currently outstanding, again, currently around $18 trillion, this amount includes about $5 trillion that is owed by the federal government to the Social Security Administration (called intragovernmental debt). This is past Social Security surpluses that were spent by the U.S. government, but with the promise to pay back those debts to the Social Security Administration when that agency begins to run deficits, which is happening now. It’s pretty clear that that debt will never be repaid, but since it is debt owed within the government it is generally seen as less consequential as “publicly-held debt”, government bonds and bills owed by individuals, businesses and other governments.
According to the U.S. Treasury, the amount of federal debt currently held by the public is about $13.1 trillion. This is up from less than $4 trillion in the early 2000s (see chart below).
Using the more inclusive level of “gross” debt outstanding of about $18.2 trillion results in a current debt-to-GDP ratio of about 104%. In the last century, such a debt-to-GDP level in the U.S. has only been surpassed during World War II. Such a level compares to (using 2014 data) about 200% in Japan, 132% in Italy, 95% in France, 89% in the U.K., 75% in Germany, 50% in India, 52% in Canada and 64% in China (source, Eurostat). Based on this measure, the U.S. has a high debt-to-GDP ratio, but is below a few of the financial basket-cases such as Japan, Italy and Greece, and not a lot higher than countries like Germany and the U.K.
But just like families, not all countries have an equal ability to pay down debt. The extent of entitlement programs, economic mobility and restrictions and the tax base all factor in to how affectively a country can tap the resources of its citizens via income tax and pay down its debts. A recent article in Forbes Magazine compared debt levels to the amount of taxation among countries. By this measure, the U.S. debt situation is nearly the worst in the world, only behind Japan and Greece as a percentage of tax revenues. It should be noted that this even doesn’t factor in unfunded liabilities, though other countries of course have their share of future demands.
In addition, it’s possible that the U.S. GDP is not even as high as is reported. The size of a country’s economy (often measured as GDP) is certainly not simple to calculate, despite the faith relied upon it by the media, politicians and investors . And if the GDP does not accurately reflect an economy’s size, then the debt-to-GDP ratio is also deceptive, and misleading to owners of that debt as well as a country’s present and future taxpayers. If this is so, all these calculations of debt-to-GDP would be even higher, and more dangerous. After all, this is an estimate of economic growth, impossible to know in such a large and diverse country. Secondly, the estimate is produced by the government itself, which has every incentive to show high economic growth, not only to provide confidence for its citizens and motivate future spending and economic growth, but also to make it easier to give confidence to the holders and buyers of its bonds.
Owning over $11 trillion in outstanding U.S. government debt, investors want to be sure they are investing in a worthwhile enterprise that has a low probability of default. Every percentage point of lower GDP means a higher percentage point of its debt-to-GDP ratio, and a higher likelihood of the government being unable to pay off those bonds. At least not without printing more money and further eroding the value of the bonds. In addition, a higher debt-to-GDP ratio and related higher perceived risk of default by the government means that the government will have to pay a higher rate of interest on its bonds. As we have seen recently in Greece, when investors become nervous about a government’s ability to pay on its debts, the interest rate on that debt can quickly skyrocket.
In the chart below I compared over two decades of changes in yearly retail and food sales in the U.S. and as well as reported Gross Domestic Product. Retail and food sales include about everything that is sold in the U.S. – vehicles, restaurant sales, furniture, grocery stores, gasoline purchases, sporting goods, health and personal care, building stores, clothing and department stores. In 2014, these sales amounted to over $5 trillion.
The total GDP of the U.S. is now reported to be over $18 trillion, leaving about $13 trillion in GDP that is made up of other “production”. In Economics 101 we learn that GDP = C + G + I + NX. Specifically, Gross Domestic Product is made up of consumer spending; government spending; business spending on capital and Net Exports (since exports are less than imports in the U.S., this ends up subtracting a little from GDP). So essentially, the economic output of an economy is measured by the amount of consumer spending, government spending and corporate spending on capital projects.
However, since government spending, and to a lesser extent corporate capital spending, tend to grow relatively consistently from year to year, it is the change in retail sales that tends to indicate the direction of the overall economy. For example, recessions nearly always occur during downturns in retail sales. During the 22-year period from the early 1990s to now, the level of retail sales is rather strongly correlated (about a 50% correlation) to measured GDP.
In this chart I tracked yearly changes in retail sales, adjusted for reported inflation (CPI), and compared this to yearly changes in Gross Domestic Product (which is also reported after adjusted for inflation). We see that generally, retail sales tracked GDP pretty closely for most years of the 1990s, with retail sales actually higher overall than reported growth in the GDP. That changed in the year 2000 when reported GDP started generally increasing faster than retail sales (or declined less). This reversal is often explained by increased government spending offsetting lower levels of retail and corporate spending.
But what I think is particularly interesting are the years from 2007 at the beginning of the recession to the present. During those years, retail sales growth has generally lagged significantly behind reported economic growth. For example, after-inflation retail sales in the U.S. only increased 3.3% cumulatively from 2006-2014, or less than 0.5% per year. In contrast, since 2006, reported GDP has increased a total of 10.6%, or about 1.4% per year. So during this eight year stretch, the rise in reported GDP in the U.S. is more than three times that of retail sales.
If GDP had actually increased at the same rate as retail sales, GDP would be about 7% lower, more than a trillion dollars below its current level. And of course, at that level, the debt-to-GDP level would be higher. Instead of about 71% or 104%, depending how you measure outstanding debt, those levels would be more like 76% or 111%, respectively.
Perhaps GDP is still accurate despite the fact that in recent years retail sales increases have been so much less than GDP. Government spending is one of the three main components in the calculation of GDP. And we know that government spending is quite a bit higher compared to 2006, up more than 30% before inflation, which is boosting reported GDP. But the fact is that all that government spending and overspending means that debt held by the public is now about $8 trillion higher than in 2006. Has that extra $8 trillion of debt and government overspending resulted in an economy $8 trillion larger than would otherwise be the case? That question may be debatable but we do not that despite all that spending and debt, retail sales are only slightly higher than the level they were at in 2006, despite 20 million more people living within the U.S. Has the economy recovered from the depths of the recession? Yes. And has it paid a high price of massive amounts of debts to be paid for with higher future inflation, greater financial uncertainty and higher taxes? How do you think the citizens of Greece would answer that question?