In an investment some debt or leverage can be good but, at some point, it can become all-consuming and impossible to repay!
Think about what happened to homeowners who had a variable-rate mortgage, also known as debt or leverage, when mortgage rates began to rise and the value of the asset fell.
If their income stayed the same or climbed slightly, but the monthly payment increased to a point that they could no longer afford to pay…
Debt renegotiation, a possible bankruptcy filing or eventually losing the property to foreclosure (short sale) are but three of the possibilities.
Government Leverage
But what happens when a government continues to borrow from investors (because they can) and at some point that debt reaches a level that can no longer be sustained let alone have any hope of ever getting paid back?
Because as mentioned above they are governments with the power to tax and not individuals who need to at least try and control their finances, they will continue to borrow at whatever rate the market will demand.
We saw this occur during the financial crisis when the so-called EU PIIGS were forced to issue debt far above the rate being offered by ‘good risk’ countries like the U.S. and Germany. Remember the charts from a Hallmark Abstract Service article back in 2014, ‘Are these 10-year EU sovereign debt yields sustainable?‘ that examined EU sovereign debt yields then compared to those present in 2012…
‘…May 18, 2012 10-year sovereign debt yields for the United States, Japan, and the five EU PIIGS (Portugal, Ireland, Italy, Greece and Spain)!
Yield spreads between the countries were at these exaggerated levels (although improved for most from the depths of the global financial crisis) due to continued concerns over the ability of these weaker EU economies to manage deficits, access the credit markets, improve economic growth and of course stay solvent in the face of demands for austerity…‘
Basically it’s the old investor adage of risk/return that says the higher the perceived/actual risk of an investment, the higher the return that will be demanded.
To make a long story short, the higher the debt-to-GDP ratio a country possesses then theoretically one would assume higher risk and therefore higher returns demanded.
Examining the list of the Top 17 countries with the highest ratios, however, this is certainly not always the case as you will clearly see by the yields demanded (or more accurately not demanded) by investors for the sovereign debt of #1!
From the article at Business Insider,
‘The 17 countries with the highest level of government debt‘
17. Iceland – 90.2%. Prior to the credit crisis in 2007, government debt was a modest 27% of GDP. Eight years on and the country is still dealing with the collapse of the banking system.
16. Barbados – 92.0%. The tax-haven nation is the wealthiest and most developed country in the eastern Caribbean, but its growth prospects look weak due to austerity measures to combat the effects of the credit crisis eight years ago.
15. France – 93.9%. The eurozone’s second-biggest economy has been recovering “in fits and starts,” says the country’s statistical agency.
14. Spain – 93.9%. S&P is confident that Spain’s buoyant growth prospects and labour-market reforms will boost its outlook.
13. Cape Verde – 95.0%. The island nation is a service-orientated economy and suffers from a poor natural-resource base. This means it has to import 82% of its food, leading to vulnerability to market fluctuations.
12. Belgium – 99.8%. The country is known as “the sick man of Europe,” because while the government managed to reduce the budget deficit from a peak of 6% of GDP in 2009 to 3.2% — its debt is still incredibly high.
11. Singapore – 103.8%. It’s one of the wealthiest countries in the world but the island nation suffers from high debt. The government is now trying to find new ways to grow the economy and raise productivity.
10. United States – 104.5%. The US hiked interest rates for the first time in seven years in December last year. In March, Federal Reserve Chair Janet Yellen said the economy was on a path of slow and steady growth.
9. Bhutan – 110.7%. The small Asian economy is closely linked to India and depends heavily on it for financial assistance and foreign labourers for infrastructure.
8. Cyprus – 112.0%. The country’s excessive exposure to Greece hit it hard when the European sovereign-debt crisis rippled across the world in 2010. Like Greece, it had to be bailed out by international creditors and enforce capital controls and austerity measures to get funding.
7. Ireland – 122.8%. The country exited its bailout programme two years ago but still faces a huge debt pile. But it’s on the right track. Ireland has already had success in refinancing a large amount of banking-related debt.
6. Portugal – 128.8%. Portugal exited its own bailout programme in the middle of 2014. However, GDP was still 7.8% lower than it was at the end of 2007.
5. Italy – 132.5%. The country’s proportion of debt to GDP is the second highest in the Eurozone.
4. Jamaica – 138.9%. The services industry accounts for 80% of GDP, but high crime, corruption, and large-scale unemployment drag the country’s growth down. The International Monetary Fund said Jamaica has to reform its tax system, among other things.
3. Lebanon – 139.7%. The country used to be a tourist destination but war in Syria and domestic political turmoil have led to a lack of an official budget for months.
2. Greece – 173.8%. The country has taken over €320 billion worth of bailout cash and it’s looking increasingly impossible to pay it all back — especially since it has had to implement painful austerity measures to get its loans. But it’s surprisingly not the worse country in the world for government debt.
1. Japan – 243.2%. The country is in a troubling spot. Its economy is growing very slowly and now the central bank has implemented negative interest rates.
Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at mhaltman@hallmarkabstractllc.com.
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