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Most individuals have a limit on the amount of debt they can acquire. This is because, at some point they will no longer be able to service the debt and bankruptcy or default will ensue. We also saw how excessive debt can damage an economy with the recent global crisis in 2008. When it comes to borrowing, the federal government has much more leeway than state government or individuals. For example, Washington has no requirement to balance its budget and can continue to overspend, leaving a trail of careless decisions to ensuing generations. In this article, we'll discuss the debt-to-GDP ratio, why it's important, how it's determined and list the seven most indebted nations based on this measure.
Why The Debt-To-GDP Ratio Is Important
The debt-to-GDP ratio is a measure of a country's debt compared to its economic output. When a country's economy slows, government will frequently borrow to meet its obligations or to stimulate its economy. If the former is the reason, it can be said that the government had very little cushion in its cash flow and the slow economy has reduced tax revenue making it necessary for the government to borrow. If the government is borrowing to stimulate its economy, for example, to create work programs for the unemployed, then it hopes that this will shorten the duration and severity of the economic downturn. In any event, excess government borrowing for whatever reason, has to be repaid and that's where this ratio is useful.
How To Calculate The Debt-To-GDP Ratio
To explain how to calculate the debt-to-GDP ratio, we'll use a hypothetical example. Assume "Country A" has debt in the amount of $1.5 million and a GDP of $1.0 million. To calculate its debt-to-GDP ratio, you would divide the amount of its debt by its GDP.
$1.5 million / $1.0 million = 150%
Hence, "Country A's" debt-to-GDP ratio is 150% since its debt is 50% greater than its GDP. For further clarity, GDP or gross domestic product, is the total output of all goods and services of a country and is the primary measure of economic growth or the lack thereof. Although there is no specific percentage to indicate when a critical point is approaching, a lower ratio is better.
Seven Highest Ratios
Japan has the dubious honor of having the highest ratio and the U.S. comes in at number six (see Chart below). Actually, Japan, Greece, Italy and Portugal are in much worse shape than the U.S. despite our $17.6 trillion debt.
Lower interest rates have been the trend since 2008. Considering all of the countries listed on the chart, the U.S. has the highest short-term government interest rate at 0.25%. Singapore's rate is 0.17%, the four European nations are at 0.05%, and Japan is at 0.00%. That's correct, Japanese short-term government debt is paying zero.
Not only is government debt high, the trend is rising as well. The following table shows the ratio of these countries in 2004 and this year.
In every country the ratio is higher and the lowest ratio occurred in 2004, with two exceptions. The exceptions are Italy (103.6) and Singapore (87.1) which had lower ratios in 2008. The point here is that the trend is higher.
What does all this mean? Whatever this data portends, it's clear that governments are continuing to acquire debt. If these governments have been attempting to stimulate economic growth with government spending, then perhaps we'll see the fruits of this in the near future. However, if they have been incurring debt to meet obligations and if economic growth doesn't return soon, we could see a global shock as countries fail to meet debt obligations. In essence, this could be a ticking time bomb or a slow path to recovery. Only time will tell.