Great SocGen Piece on Sovereign Debt

Okay, I know I am a little late to the party when it comes to discussing sovereign debt, but I read an article a while back that really struck a cord and I thought should be shared. Fear not, I am not here to rattle off a bunch of platitudes about the causes of and potential solutions to the situation in Greece.  What I want to discuss is an excellent piece from SocGen's Popular Delusions series which honestly examines the bigger picture, specifically, western countries' sovereign debt situations.

The authors begin with an examination of people's (and governments') tendency to put off tough decisions and responsible action "for later", within the context of irresponsible government spending.  The discussion then transitions to an examination of government off-balance sheet obligations, before moving to the arithmetic of sustainable government debt. Summarizing the (extensive) literature on the topic, the authors assert that "maintaining a stable debt to GDP ratio requires governments to run a primary balance [surplus before interest] proportionate to the difference between interest rates and GDP growth" - a rule of thumb so logical it is irrefutable. This rule is applied to various countries' debt situations based on the very conservative assumption that current costs of financing will persist in the future.  Their findings are summarized in the following bar chart.

For those with a thorough knowledge of governments' recent fiscal histories, this graph is all that is necessary to differentiate the sinners from the saints.  For those not as familiar with this history, the next chart summarizes it nicely for you.

Putting the two together is the real show-stopper...

This series of charts make it clear that a number of countries in the West (and Japan) have a lot of fiscal consolidation to do in the coming years - not a particularly original insightful.  Now consider what will happen when this year's deficits are added to the governments' respective mountains of debt and government funding costs tick upward as monetary policy tightens - whenever that may be.  If a host of countries couldn't get their finances in line over the last decade, what is there to make us believe that they will be able to do so in the "New Normal" economic environment of high unemployment and sluggish growth? Hope may spring eternal, but the latest CBO baseline forecast - and its analogues from other developed countries - aren't cause for much optimism.

The entire SocGen report is definitely worth the 20 minutes.