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“So where do human beings go when they die?” she asked as soon I sat down on the sofa.

“Huh?” I looked at her stunned.

“Oh. I was just wondering. The rains have made me rather gloomy.”
“They go to heaven,” I replied.

“Heaven?”

“Yeah as the British author wrote in his book, The Black Album, “Heaven, surely, as someone said, was man’s easiest invention.”

“But that does not answer my question.”

“Well I am no Osho. How do you expect me to answer something as complicated as that!But I will answer any other question that you have,” I said with a smirk on my face.

“Okay. So last week you were telling me that that Japan has a debt to gross domestic product (GDP) ratio of 227%. Isn’t that a huge number?”
“Yes it is. What it means is that for every one yen of GDP they have 2.77 yen of debt,” I explained.

“See what I wanted to know is that at such a high debt to GDP ratio why hasn’t the country defaulted till now?”

“Good question. Let me take a slight detour to answer that. I was reading a rather interesting research paper titled, — Ask not whether governments will default, but how, written by Arnaud Marès of Morgan Stanley. As he writes, “Several advanced countries have experienced debt/GDP levels well in excess of current ones. The US emerged from World War II with a public debt/GDP ratio of approximately 110%, and the UK with a ratio of 250%...the UK government never defaulted through that period. France’s public debt stood at about 280% of GDP at the end of World War II.”

“And as you told me last week, for Greece the ratio is at 115%, Italy is at 120%, Belgium is at 100%, the US is at 93%, France is at 84%, Portugal is at 87%, the UK is at 78% and Ireland is also at 78%. I remember that.”
“Okay, good. Now tell me how does debt of any country accumulate?”
“Oh that’s simple. When a country spends more money than it earns through various kinds of taxes, it borrows to fill the gap.”

“Exactly. Now at the end of World War II, the debt was because of the money needed to finance the war and once the war ended the debt stopped growing. As Marès writes, “Governments were no longer running deficits, nor were there expectations of them doing so in subsequent years.” But that is clearly not the case currently. Most western economies are running huge stimulus packages as well as welfare programmes to turbo-charge their economies and are expected to continue to borrow huge amounts. As economists say, deficits now are structural in nature. Given this, the debt to GDP ratio of a country does not always give you a correct picture.”

“Then what does?” she asked.

“Well, what matters is the ability of the governments to service these huge debts that they have managed to accumulate. As Marès writes, “An even better approach would be to scale debt against the maximum level of revenues that governments can realistically obtain from using their tax-raising power to the full. And when you do that, the numbers get very interesting (See table). The US has a debt to GDP ratio of 53%, which is low when compared to countries in Europe. But its debt to revenue ratio is 358.1%. That means the ability of the US to continue servicing its debt is under doubt because it isn’t earning enough. Same is the case with countries across Europe. There isn’t enough money going around to service all the debt.”

“What about Japan?”

“What has saved Japan till now is the fact that it had a very high savings ratio. So the Japanese government just kept borrowing from its citizens.”

“So what’s the moral of the story?” she asked.

“As Marès puts it, “It is not whether to default, but how.”

“How?”

“I explained that last week.”

“Then do it again,” she said.

“There are countries which have debts in their own currency and there are countries which have debts in foreign currency. Of the heavily indebted PIIGS countries, other than Italy, the other countries have a major portion of their borrowings in foreign currencies. Then there are countries like the US, the UK and Japan, whose borrowings are mainly in their own currency. Now, countries which owe money in foreign currency cannot print money to repay, so their chances of default are high. That’s not the case with countries who can print money — the US has almost all of its government debt, even though more than half of it is owned by foreigners, in dollars. In the UK, almost one third of government debt is owed by foreigners. So these countries can print money and repay their debtors. Of course, that creates another set of problems. But that’s a risk governments may be willing to take.”

“So death is inevitable?”

“Yes as the line from the movie Anand goes “Maut tu ek kavita hai…mujhse ek kavita ka vaadaa hai milegi mujhako…”

(The example is hypothetical)

References:
The headline and a major part of this article is borrowed from Sovereign Subjects: Ask Not Whether Governments Will Default, but How, Arnaud Marès, Morgan Stanley, August 25, 2010
Reflections on the Sovereign Debt Crisis - Edward Chancellor