Debt Matters

Does a nation’s high debt cause slow growth?

That’s the operative question as the US, Europe, and Japan face budget challenges. Carmen Reinhart and Ken Rogoff studied fiscal policy in sixty-six countries over eight centuries and determined that highly indebted countries—where the public debt is about equal to the GDP, or higher—grow more slowly than less indebted countries.

So strategies to rein in the deficit in the US—currently 7% of GDP—are making the rounds. If we are to avoid the slow-growth trap, the reasoning goes, we need to reduce deficit spending that would raise our debt-to-GDP ratio.

But correlation is not causation. Yes, slow growth and excessive debt are associated with one another. But studies showing that people who lose weight tend to own bathroom scales don’t prove that if you go out and buy a bathroom scale you’ll lose weight. It could be that slow growth economies are prone to acquire more debt. Or it could be that something else affects both factors.

Most economists agree that our long-term fiscal picture must be set in order, and this requires reforming “entitlement spending”—Medicare, Medicaid, and Social Security. The formulas that determine the level of benefits are unsustainable and need to be revised. But in the short run the economy’s tepid performance means it needs all the help it can get. Debt isn’t a free ride to growth—if it were, Spain and Greece would be growing like crazy. But reducing spending suddenly could be disruptive, and might even cause the economy to contract.

The fundamental structure and competitiveness of an economy matter more than the level of debt. Debt and deficits matter—but other stuff matters more.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2017-07-17T12:34:54+00:00 May 2nd, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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