Sovereign Debt Like Radiation Poisoning

The double tragedy in Japan of tsunami destruction and radioactive contamination triggered an idea the other day.

Let us compare the effect of different radiation levels on human beings and debt levels on sovereign states.

(rem)          Health Effect                               Time to Onset
(without treatment)
5-10       changes in blood chemistry
50           nausea                                                hours
55           fatigue
70           vomiting
75           hair loss                                              2-3 weeks
90          diarrhea
100        hemorrhage
400        possible death                                 within 2 months
1,000     internal bleeding & death                 1-2 weeks
2,000     loss of consciousness;                      minutes
              and death                                       hours to days

As the table indicates, at low levels of radiation the effects are unpleasant but survivable. As radiation levels rise, a threshold is crossed which poisons the person so much that death is likely without treatment. The threshold levels seems to be 400 rem. At that level death does not come instantly, but poisons the body enough for the individual to survive for 2 months before succumbing to the radioactive poison.

A similar effect can be seen with sovereign states that accumulate large amounts of debt. While the cut off level is not as clearly pronounced as with radioactive poisoning, and depends on whether the debt is held primarily externally or internally, the long term consequences are the same. As I have argued in the past, once the 80% debt to GDP level is exceeded, the point of no return is reached without severe and immediate treatment. If the debt is not addressed and continues to increase, the economic health effects can be felt sooner and more severely as we see in the example of Greece.

The warning here is that sovereign debt can and does accumulate rapidly.  Recall that both Iceland and Ireland had relatively low debt levels back in 2006 (around 50% of GDP) but bank bailouts and associated "stimulus" measures quickly drove the debt toward 100% of GDP.  Iceland wisely let the banks fail and the economy is gradually recovering, but Ireland determined to prevent bondholders from taking a haircut and now is looking at another massive bank bailout.

This story will not have a happy ending for the Irish. The economy will die from Sovereign Debt Poisoning.

What is even more troubling is that all the G8 countries carry very high debt loads, including both the US and Canada and are already at or near the 80% threshold.  The only reason that a second crisis has not begun is the lack of an appropriate trigger.  I suspect that a large bailout for Spain may be enough to push the bond market over the edge.  The cost of rebuilding in Japan is another potential trigger.

Impact of Growing Government Debt on Growth

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP.
Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70-80% of GDP, which calls for even more prudent indebtedness policies.

At the same time, there is evidence that the annual change of the public debt ratio and the budget deficit-to-GDP ratio are negatively and linearly associated with per-capita GDP growth.
The channels through which government debt (level or change) is found to have an impact on the economic growth rate are: (i) private saving; (ii) public investment; (iii) total factor productivity (TFP) and (iv) sovereign long-term nominal and real interest rates.
From a policy perspective, the results provide additional arguments for debt reduction to support longer-term economic growth prospects.


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