Comparing National Debt: U.S. and Japan

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by: Erik Dellith

A couple of interesting articles caught my attention over the last few days. In the first, former Treasury Secretary and Presidential Economic Advisor Larry Summers wrote about the importance of further stimuli to keep a depression at bay and avoid a lost decade. The second, Pedro Nicolaci da Costa of Reuters wrote that Federal Reserve Chairman Ben Bernanke warned of a crisis if the federal debt level is not raised. Neither article is truly surprising, given the current state of the economy. Still, the articles gave me reason to pause and think about the debt level of the U.S. and other countries.

Stimulus and Debt

In his op-ed piece, Professor Summers discusses several initiatives, including expanding the payroll tax cut and enhanced infrastructure spending. His proposal has an estimated price tag of $200 billion. Reflecting on the labor market alone, I can appreciate the desire to give the economy an additional boost, though I admit that I do not know the full extent of the efficacy of such a program. Will there be some short-term benefit to the economy from such an initiative? Undoubtedly. How large and how long lasting?

Of the many good points he makes, another Summers addresses is infrastructure. Now would be a good time to repair or replace much of America's aging infrastructure, since borrowing costs are very low and there are many unemployed construction workers. This makes complete sense. Build out while you can do so cheaply.

In looking at the deficit and the current state of the economy, one could easily argue that the benefits of action outweigh the costs. That brings us to Bernanke's recent comments about the importance of raising the $14.3 trillion debt ceiling. At this point, $200 billion in additional debt doesn't seem like that much. What's another shovelful of dirt on top of an existing large pile? (Note: tongue-in-cheek) But this begs the question: How helpful would this additional stimulus really be?

Note a few other factors here. For starters, in thinking about this, I am reminded of an article that Paul Krugman wrote in July 2010, where he explained that the earlier fiscal stimulus had been too small. This leads one to wonder: Would another round of fiscal stimuli be large enough to significantly improve the economy?

One could argue that we don't need too much help now, so the $200 billion would be sufficient. After all, we already have a lot of stimuli in the economy. The Fed's $600 billion QE2 is only now drawing to a close and we know that there is a lag between a change in monetary policy and the time it takes to fully work its way through the economy. That said, if these were "normal times" we could expect benefits in the second half of this year and next year from the Fed's move today. However, these aren't normal times. The market has been flooded with cash and interest rates have been near zero for while. This environment reminds me of the liquidity trap in which Japan was caught through much of its lost decade.

Starting in the early 1990s, Japan wrestled with stagnant growth and deflation, triggered by the bursting of asset price bubbles in both the equity and real estate markets. In an effort to stimulate growth, banks wrote off bad debt (though more kept creeping up for a while), interest rates fell and the government took on considerable debt as it spent (arguably too little) on various projects, including infrastructure. The result? Japan's economy continues to flounder, but it has amassed a truckload of debt. How much debt? The graph below compares Japan's gross government debt as a percent of GDP to the average for developed economies.

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(Click to enlarge) Source: IMF, actual and estimates. (For the graph above, I use the "developed economies" classification according to MSCI, as I discussed here.)

Notice how Japan's gross debt as a percent of GDP moved in line with the average of developed economies until the government took steps to spend its way out of its crisis.

What about the U.S.? Have banks written off bad debt? Check. (Though more bad debt may creep up until real estate and the job market recover.) Have interest rates been slashed? Check. Has the government used fiscal policy to boost spending and, in the process, taken on a lot of debt? Check. Has the economy continued on a muted growth path? Check (at least as far as the labor market is concerned).

How much debt does the U.S. have and how does that compare with other developed countries? The graph below provides us with a quick snapshot.

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(Click to enlarge) Source: IMF, actual and estimates

We see that U.S. gross debt as a percent of GDP moved roughly in line with the average for developed economies until the most recent financial crisis. Note that the U.S. level, though higher than average, is still a far cry from Japan's level. The IMF estimates that Japan's gross debt will stand just under 230% of GDP this year. Rounding out the top five, we have Greece at 152%, Italy at 120%, Ireland at about 115%, and the US at just about 100%.

Clearly the U.S. has several factors going for it that other countries do not. It is the world's largest economy and the dollar is the key reserve currency. This gives it a bit more flexibility. Nonetheless, there is concern about its current debt level. That said, we may want to be careful how much more dirt we pile onto the existing heap, and make sure that the benefits do, indeed, outweigh the costs. The recent history of Japan provides us with some insight of what could happen if we don't.

(Note: There are many factors that contributed to Japan's lost decade and its more recent struggles. It is impossible to sufficiently cover those factors and all the similarities and differences with the U.S. in a short article. As such, the comparison here is limited.)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.