One of the most cherished ideas in the analysis of sovereign debt is that debt-to-GDP is a useful measure of a country’s credit stress.
For example, Germany hopes the Eurozone can avoid another sovereign debt crisis like the one its currently in if country’s are forced to keep sovereign debt at around 60% of GDP.
Conversely, economists like Reinhart and Rogoff have argued that countries start to get into trouble when debt tops 90% debt-to-GDP.
Other economists have argued that when debt hits 80% of GDP, a country’s growth tends to get suppressed.
So you get the point, a lot of people think debt-to-GDP is a big deal.
So you’d think, then, that with investors more attuned to sovereign debt issues than ever, that countries with a higher debt to GDP ratio would pay more to borrow.
Well, that turns out to be wrong.
Using data from Bloomberg, we looked at basically all of the big emerging and developed markets* with a big bond market, and good data on debt to GDP and decided to check to see if there was any connection at all between debt to GDP and the yield on their 10-year bonds.
The answer, quite clearly, is no.
In fact, using an exponential regression, we detect a slight shift down and to the right, meaning that the more debt a country has relative to its GDP, the cheaper it is to borrow.
This chart even includes the ultra-outlier Greece, which A) is highly unusual and B) is super-tiny, and yet is given the same weighting as Japan in our system.
Photo: Data via Bloomberg
Something you hear less about is a country’s annual surplus/deficit vs. 10-year yields. There you observe a very tiny borrowing.advantage to countries running a surplus, but basically there’s no pattern at all.
Photo: Data via Bloomberg
The fact of the matter is that the traditional metrics just don’t matter that much, even in this time when investors are ultra-concerned about which countries might not pay them back.
As we established this weekend, when comparing Finnish and Swedish yields, what really matters these days is whether a country is borrowing in its own currency (Finland, which borrows in Euros has seen its yields shoot up, while for Sweden it’s the opposite).
The unfortunate thing about myth that debt-to-GDP is useful is that it’s costly. It’s essentially what caused Bill Gross to get his famous Treasury short so wrong earlier this year. The myth also causes policy errors, as countries that ought be spending and borrowing more feel the need to reduce their debt arbitrarily.
* The full list of countries: