Back in April, most economic commentators snorted at Standard and Poor's decision to slap a negative outlook on U.S. debt. Although there are some reasons why this action actually made sense, it definitely raised a question: how bad will the debt problem in the U.S. have to become to result in an actual downgrade? Ultimately, it depends on the will of Washington to fix it. And that's what has S&P so worried. It might be helpful to put U.S. debt in context. So let's compare it to another large, developed nation that ran into debt woes a decade ago: Japan.
Let's go right to the chart, and then I'll explain it:
There's a lot going on here. First, the lighter bars are projections by the IMF, which is the source for almost all of this data. Only the 2010 value for U.S. debt-to-GDP comes from another source. I calculated it using the net debt level from the Treasury's website and GDP from the Bureau of Economic Analysis. It is the dark blue bar. Incidentally, what I calculated was very close to the IMF projection.
The red line represents the debt burden of Japan when S&P downgraded the nation's debt from AAA to AA+. This occurred in February 2001, which means that its debt burden is most closely reflected by the end-of-year figure for 2000. At that time, net debt-to-GDP was 60.4% for Japan.
If you follow this red line across to present day, you can see that it first intersects the U.S. bars in 2010. In fact, last year, U.S. debt-to-GDP exceeded Japan's level when it was downgraded. For 2010, it the ratio for the U.S. was 64.1%
This chart is striking in another way: the path that Japan took last decade very closely resembles the path the IMF expects the U.S. to take this decade. Here's a bonus chart, using the same data, but putting Japan's data from last decade side-by-side with the U.S. projection for this decade:
You can see how closely Japan's debt-to-GDP follows the trajectory set by the IMF.
If the U.S. does, indeed, follow this trajectory, is a debt downgrade inevitable? You might think so, but the U.S. could fare better. Although Japanese and the American economies have many similarities, they also have many differences. When I asked S&P about this, they pointed out a few key features that distinguish these two economies from one another:
- The U.S. has better fiscal indicators, both on the stocks and on the flows.
- The dollar remains the key international currency, while the yen is a distant third.
- U.S. prices are more stable, while Japan flirts with deflation.
- The U.S. growth prospects are better.
- Japan has particularly troubling demographics, as its population is aging and skews towards the elderly.
So for now, U.S. will maintain its AAA rating. But if the nation doesn't get its fiscal house in order, the rating agencies may eventually see past those advantages the U.S. has over other nations and worry more about its ability to service its enormous debt burden.