Some Basic Math

This week, I plan on posting a few short blogs.  They’re already (mostly) written, so I actually feel some confidence that this will happen.  On to today’s thought…

Greece, Italy and the United States

Current estimates are that Greece’s debt-to-GDP ratio is around 160%.  The goal is for this to be 120% in 2020.  Currently, Italy’s ratio is 120%.  Reinhart and Rogoff have shown that economic growth starts to slow when the debt-to-GDP ratio of a country exceeds 90%.

You don’t need to know anything about economics to do some basic math.  Here it is…let’s imagine a country with debt-to-GDP of 120%.  Let’s also imagine that the country pays interest of 6% (that’s what Italy is currently paying; Greece is paying much more).  If that’s the case, you’re paying interest that is equivalent to 7.2% of GDP.  (That’s 120% x 6%.)

Italy’s tax revenue is around 22% of GDP.  If one-third of their tax revenue is needed to pay interest, the numbers don’t work out.

Of course, this same math is true for the United States.  Our debt level is not that high yet (our publicly held debt is above 60% of GDP and our total debt is above 90% of GDP).  In addition, our interest rates are very low.   But, if interest rates ever increase, the math will work the same for us as it does for Italy and Greece. One other random thought…I don’t understand why anyone would buy a credit default swap on a sovereign debt.  If Greece’s bailout can be fashioned as a “non-default” (when private investors will “voluntarily” take a 50% haircut), it’s hard to imagine what type of restructuring would actually be considered to be a default.