Saturday, May 18, 2024

No doubt about debt – is it time to push panic button?

It’s no secret – North America has got some serious debt issues.

The U.S. debt is projected to surpass $23.53 trillion USD, and Canada $1.12 trillion CAD in net general government debt in 2021.[1]

Should you be worried? Many mainstream media headlines would have you believe so:

Global credit rating agency issues new warning over Canada’s coronavirus spending, debt

Your share of Canadian government debt: more than $34,000

Massive deficit to be revealed today begins new era of debt for Canada

But how much truth is behind these headlines? Have recent government handouts in light of the COVID-19 pandemic doomed our children to a life of high taxes and little opportunity? Let’s ask some questions and look at real numbers to help determine an appropriate level of panic.

How bad is the current debt situation?

While there is always more than one way to measure something, net debt to GDP (gross domestic product) is the most generally accepted gauge. This approach, which compares the value of all goods and services produced in a given country (GDP) to debt, allows you to see which is growing faster; economic progress or debt.

A low debt-to-GDP ratio tells us that an economy is producing and selling enough goods and services to pay back its debts without incurring further debt. Conversely, a high debt-to-GDP ratio indicates that debt is growing faster than goods and services are being produced.[2]

While we investigate debt to GDP, it is important we keep in mind that this is just one estimate in determining a government or an economy’s ability to pay down debt. Other variables such as a country’s credit rating can influence a government’s ability to reduce financial liabilities. Credit ratings affect investor confidence by signaling the level of risk in making investments related to a particular country.[3] The economic and political environment, which can include debt, deficit, and political risk, can all influence a country’s credit rating.[4] Such ratings are a credit agency’s way of determining the likelihood that governments will be able to meet future debt obligations. For context, credit agency Fitch rated Canada’s credit rating at AA+ with a stable outlook and the United States at AAA with a negative outlook in 2020.[5] Keep this concept in mind as we delve into debt.

Let’s focus on Canada for a moment. (You can click on other countries under the headline to temporarily hide their data.) Two anomalies stand out:

  • What the heck happened in the 1990s in Canada, and what was done to lower the ratio?
  • There is a significant spike in 2020.

While we are not here to do a deep dive on Canada’s debt-to-GDP during the ‘90s, here is some historical context. The Canadian government was spending beyond its means in the ‘90s and interest payments were high. Major credit rating agencies downgraded Canada from AAA to AA.[6] Spending cuts and tax hikes[7] were the Canadian government’s main mechanisms to bring its budget into balance and win back its AAA rating.[8]

The steep incline of Canada’s line on the debt-to-GDP chart in 2020 could be unsettling, although the World Economic Outlook Database projections indicate that Canada has reached the apex.

Watching the U.S. debt level climb, it is clear that net debt to GDP has been on the rise for more than a decade. In 2000, the U.S. was given a AAA (stable outlook) rating from Fitch. While the rating is the same, the current negative outlook indicates that the rating is close to being downgraded.[9]

Unlike the forecast for Canada, the U.S.’s net debt to GDP is projected to continue its climb at a similar rate.

Comparing these findings with the other G7 countries, Canada is at the bottom of the group with a net-debt-to-GDP estimate of 46% for 2020. The U.S. is in the middle of the pack with a net-debt-to-GDP figure of 107% for 2020.

The top net-debt-to-GDP “offenders” in the G7 are Japan, with a 2020 estimate of 177%, and Italy at 149%. Japan has held a high level of government debt historically[10] and experienced past fiscal crisis, but its recent GDP performance[11] shows a growing economy. These arguably stable countries have much higher net-debt-to-GDP figures than their North American counterparts. If other stable countries can survive on high net-debt-to-GDP ratios, does that mean Canada and the U.S. can continue to sink further into debt without major economic distress? What if it continues to grow, and grow, and grow? Looking the U.S. debt level climb in real time at www.worldometers.info/us-debt-clock

is one way to give yourself a scare.

How bad could it get?

Many countries have faced economic crisis over the years. But where do Canada and the U.S. fall on the spectrum? Are they headed toward economic chaos? Are we already there?

To help put things in perspective, let’s take a look at Italy, which was one of the countries hit hardest by the 2008 economic crisis and suffered a double-dip recession in 2012-13,[12] and Spain, which suffered financial crisis from 2008-2014.[13]

We will summarize the findings and relate them to each country’s respective historic credit ratings.

Italy

In 2006, Italy’s credit rating from Fitch was AA- stable. By 2012, it had been downgraded by the same agency to A- with a negative outlook.[14] Focusing on Italy’s net debt to GDP in the graph above, we see a spike in ’08 followed by years of increases. While the country’s credit rating was at BBB- and stable for 2020, net debt to GDP is still at a high.

Spain

From AAA rating by Fitch in 2003 to AA+ in 2010 (but still stable), Spain hit its lowest Fitch rating at BBB with a negative outlook in 2012. By 2018, the country’s credit rating was up to A- with a stable outlook.[15] Looking back at our net-debt-to-GDP graph, Spain saw its climb begin in 2008, and while the ratio seems to be falling, current levels are nowhere near pre-2008 numbers.

What could this tell us? While debt to GDP is a great indicator, it does not capture the full picture of economic stability or a government’s ability to service or pay down debt. Examination of credit ratings can foster a better understanding, but ultimately there are many variables. Net debt to GDP does not fully capture all the social, economic, and political variables that define a country’s overall economic stability.

As the COVID-19 crisis continues to punish economies across the globe, governments including those of Canada and the U.S. are under pressure to issue major financial aid.[16],[17] Much of the North American business community is struggling to get back to full operational capacity and bring employees back to work, so it is no surprise that debt to GDP is on the rise.

However, the driving factors of the COVID-19 pandemic are very different from those of the social and political unrest that contributed to past economic crises (e.g. wide-scale loss of income and property).[18]

All that said, should we be worried about growing debt?

While some of the G7 countries’ net-debt-to-GDP ratios are forecast to fall (Canada, Germany, Italy) by 2025, others are projected to continue to climb (United Kingdom, U.S., France, Japan). If those countries are in a good political, financial, and socioeconomic place to service or pay down future debt – as evaluated by credit agencies – they may be able to manage high ratios and avoid economic disaster. Paying down federal debt requires a rigorous plan with fiscal restraint while creating economic opportunity for citizens to thrive. Do you have faith that our governments will be able to achieve this?

 

[1] https://www.imf.org/en/Publications/WEO/weo-database/2020/October/weo-report?c=156,132,134,136,158,112,111,&s=GGXWDN,&sy=2000&ey=2025&ssm=0&scsm=1&scc=0&ssd=1&ssc=0&sic=0&sort=country&ds=.&br=1

[2] https://www.investopedia.com/terms/d/debtgdpratio.asp

[3] https://www.investopedia.com/terms/s/sovereign-credit-rating.asp#:~:text=provinces%2C%20or%20municipalities.-,Investors%20use%20sovereign%20credit%20ratings%20as%20a%20way%20to%20assess,debt%20obligations%20in%20the%20future

[4] https://www.investopedia.com/terms/s/sovereign-credit-rating.asp#:~:text=provinces%2C%20or%20municipalities.-,Investors%20use%20sovereign%20credit%20ratings%20as%20a%20way%20to%20assess,debt%20obligations%20in%20the%20future

[5] https://tradingeconomics.com/canada/rating

[6] https://tradingeconomics.com/canada/rating

[7] https://www.semanticscholar.org/paper/The-Sources-of-the-Recession-in-Canada-%3A-1989-1992-Wilson-Dungan/aec7921e41844189816ed79117f4d812e6195184?p2df

[8] https://nationalpost.com/news/canada/analysis-what-canadas-debt-crisis-in-the-90s-can-and-cant-teach-the-u-s

[9] https://www.maalot.co.il/publications/mt20131212112758c.pdf

[10] https://thediplomat.com/2013/08/japans-debt-about-3-times-larger-than-aseans-gdp/

[11] https://www.imf.org/en/Publications/SPROLLs/world-economic-outlook-databases#sort=%40imfdate%20descending

[12] https://blogs.lse.ac.uk/eurocrisispress/2013/10/08/the-demise-of-italy-and-the-rise-of-chaos/

[13] http://www.eco.uc3m.es/temp/dolado2/EJ_2012_FRvsSP_BCDL.pdf

[14]https://tradingeconomics.com/italy/rating#:~:text=Standard%20%26%20Poor’s%20credit%20rating%20for,(high)%20with%20negative%20outlook

[15] https://tradingeconomics.com/spain/rating

[16] https://www.canada.ca/en/department-finance/economic-response-plan.html

[17] https://www.usaspending.gov/disaster/covid-19

[18]https://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/20_scps/2009-10/01_programme/el_2010-01-15_sp_en.pdf

 

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