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Where's the point of no return for debt?

at 10:13 AM ET, 12/15/2011


An ominous-looking stock indicator in Athens. (Petros Giannakouris/AP)
Yesterday, Italian 10-year bond yields quivered above 7 percent yet again. Many analysts have deemed this level intolerable: basically, the amount that Italy has to pay to borrow money has risen so high that the cost of servicing the country’s debt threatens to increase far more quickly than its GDP. That, in turn, means Italy’s debt load would eventually spiral out of control. Bad news.

So how can we tell when countries hit this point of no return on their debt? A new report from Moody’s Analytics tries to measure the concept of “fiscal space” — how much room a country has before its debt becomes unsustainable. The nickel version is that the United States seems to be in no immediate fiscal danger. But a couple of crucial countries in Europe are inching perilously close to the red zone (the zone where Greece, Italy, Portugal, and Ireland are all currently residing). Which, as Ryan Avent points out, means we could very well be heading for yet another flare-up of the euro crisis as soon as European countries resume auctioning off debt early next year.

The Moody’s report, written by Mark Zandi, Xu Cheng, and Tu Packard, defines “fiscal space” as the difference between a country’s current debt load and the point at which the country is on track to default on its debt unless policymakers take drastic and very unprecedented action. That means this is partly a political judgment. Countries that have shown themselves willing and able to dramatically hack their debt in short order — like Canada and South Korea — get more benefit of the doubt. Countries that tend to get bogged down in gridlock whenever reforms get proposed — Japan really stands out here — get much less room to maneuver. Here’s Moody’s chart:

That middle column shows the difference, in percentage points, between a country’s current debt-to-GDP ratio and the point at which unprecedented and gruesome cuts (or else some sort of external bailout or default) would need to happen. Ireland, Italy, Greece, Portgual, and Japan no longer have any space. Notice, too, that Moody’s thinks the United States is far from immediate danger, with about 170 percentage points of space — although, the authors are quick to insist that they’re not calling for complacency, as the gap will narrow in the coming years if the country doesn’t bring its budget deficits back down.

The last column, though, is particularly relevant for Europe. It shows just how high a nation’s borrowing costs would have to rise before that country’s debt load becomes unsustainable. Spain’s “survival rate” for 10-year bonds is just 6 percent — and Spanish yields have already risen above that level several times in the past year, including just a few days ago. Moody’s also thinks Belgium, France, and even Austria are tottering close to the edge. The authors note that, unless the European Central Bank moves to prevent borrowing costs from rising, debt loads in Europe could easily get out of hand.

In other words, don’t expect Europe’s debt crisis to go away any time soon — especially once the euro nations start implementing fresh austerity measures that risk bogging down economic growth further, as last Friday’s deal demanded.

 
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