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Understanding National Debts

March 11, 2010

Shown here is the US public debt in nominal dollars as well as percantage of GDP since 1940s. The debt reached it’s peak in 40s owing to participation in WWII and many other social programs implemented by President Rossevelt and Truman. Gross debt is expected to reach 100% of GDP by 2012. It’s interesting to understand the economics of the world where one country crumbles under such huge debts while the other survives. What deteremines the success or failure of economies? Here’s another interesting graph of UK debt over the years and it can be seen that debt has crossed 100% GDP mark way beyond several times (mostly during wars), still it sruvived. Why one country with debt as high as 150% of GDP survives while the other with same level of debt has to be liquidated?

Prof Krugman (Economics Nobel Prize winner in 2008) from Princeton points out in his blog, The Conscience of a Liberal, that the answer lies in the confidence of the investors and confidence in the political will of the country. If the investors believe in the country’s resileince and political will they will continue to provide lower interest rates(currently 10-year term interest rate in US is ~1.4%). All the country needs is to serve this interest rate in order to stabilize the debt-to-GDP ratio, which can be a very low % of GDP and manageable, given the interest rates are very low and a better growth rate of the economy can help even more. The problem arises when the investors lose the confidence and ask for higher interest rates which can ultimately lead to collapse of the whole system. In Proff Krugman’s words “The actual level of debt has some influence — but it’s not as if there’s a red line. Instead, it has a lot to do with the perceived responsibility of the political elite. If you’re worried about the US fiscal position, you should not be focused on this year’s deficit, let alone the 0.07% of GDP in unemployment benefits Bunning tried to stop. You should, instead, worry about when investors will lose confidence in a country where one party insists both that raising taxes is anathema and that trying to rein in Medicare spending means creating death panels.”

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