Fed's Dilemma: Debt-to-GDP Ratios Dramatically Understate the Debt Problem

Reader Lars writes, 'Debt-to-GDP ratios understate the true nature of the problem.' He uses Greece as an example.

Reader Lars from Oslo, the capital of Norway, and a long-time reader of this blog, questions the widespread use of debt-to-GDP as the true measure of the debt problems of a country.

Hello Mish

As we approach the next debt crisis it's time to ask some questions.

The widespread measurement of the debt problems of a country is DEBT as a percentage of GDP.

Few analysts question this ratio. But this is how I see things.

GDP = Consumption + Investment + Government Spending + Net Exports.

In simpler terms, GDP is the sum of the private sector plus the public sector plus the net trade balance.

However, only the Private Sector pays taxes and that is what enables debt service. In fact, the private sector must service its own debt as well as that of the public sector.

Thus, a better metric to measure debt levels is private sector GDP as reflected in tax income. This tells us the true brutal story of the debt problem.

Using Greece as an example, the real public debt is over 300% of GDP. Given that Greece's private sector is less than 50% of GDP, the brutal reality is that Greece has a debt level which is over 600% of Private Sector GDP.

The Greek state takes in around €65 billions in tax. This is approximately 10% of total debts.

During the previous Greek debt crisis, economists noted that Greek debt was less than 2% of global debt.

The problem is that the rest of the world is not going to service the Greek debt. The Greek taxpayer will service the Greek debt, and for him the bill is insurmountable.

In the US, the US federal tax intake is around $3.7 trillion. Total debt is $21 trillion plus off balance sheet items minus inner governmental debt.

If we start to measure debt against the income of the individuals that will service this debt, we get a more correct picture of the challenges today.

We are fooling ourselves with this Keynesian debt-to-GDP measurement.


Greek Debt

I questioned Lars about Greek debt.

I created the feature chart from a download from Trading Economics and that shows Greece's debt-to GDP ratio at about 175%.

Reply From Lars

The Greek Clock Debt shows national debt at €344 billion, a Target 2 balance of about €48 billion, loans to the private sector of €87 billion, and debt to the EU of €50 billion.

Hidden debt in special purpose vehicles (SPVs) makes the total an unknown amount higher, but the number is over €500 billion.

GDP is roughly €160 billion. Thus, debt is in excess of 300% of GDP. The private sector is roughly 50% of GDP. That yields a more realistic measure of 626% debt to private GDP.

My main point is that the debt level is high and if you measure debt against the income of those who will service that debt, the problem is enormous.

Servicing Debt

Debt, and the ability to service it, is the problem.

Lars added this thought "Most people suggest the debt will never be repaid, so it does not matter. But debt has to be serviced and rolled over. At what price? Slightly higher rates will kill most borrowers. Greece survives only because of subsidized rates."

Fed's Dilemma

Raising the interest rate will not help the problem, yet keeping rates low only encourages more eventually unserviceable debt.

ECB's Dilemma

In case you did not notice, the ECB's dilemma with Italy and Greece is even worse than the problem the Fed faces.

For discussion, please see Germany Accuses Italy of "Debt Blackmail": Hello EU, Time for Reform Expired.

Mike "Mish" Shedlock

Comments (16)
No. 1-16

Mish wrote: "Raising the interest rate will not help the problem, yet keeping rates low only encourages more eventually unserviceable debt."

Hate to borrow a Greenspan term, but that is the Fed's conundrum in a nutshell. As a society we chose to make our bed in a ZIRP environment, now we have to lie in it.


Fundamentally, it doesn’t matter whether someone’s contribution to GDP is accounted for as “public sector” or “private sector.” A doctor in Norway’s public health care system, wouldn’t suddenly make debt service any less onerous if the “system” was changed to mandate that current tax spending on health care instead be handed to a notionally “private” insurer and HMO, who ended up doing the exact same thing.

Instead, what counts wrt the ability to service debt (in real terms), is total, real, value add across the economy. Some public jobs add value (think build roads). Some don’t (babbling about who gets to leer at whom in San Francisco restrooms.) Some private jobs add value (again, building roads….). Some don’t (chasing ambulances.) Etc…..

In general, I think the perception (probably borne out of reality…..) is that the average private sector job is more likely to add value than the average public sector one. Leaving the gist of the letter’s point at least somewhat intact.

Traditionally, back in Rothbard’s and Ayn Rand’s day, comparing the US to the Soviet bloc, this was certainly the case. But now…… With financialization rendering most of what passes for “private sector,” both in the US and Norway, little more that a series of rackets aimed at being on the right side of who benefits vs loses out from the debase and regulate game, it’s anybody’s guess.

With a “private sector” consisting of rent seekers, and a “public sector” consisting of those collecting for them, I’m not sure if picking favorites really amount to a hill of beans in either the US or Norway anymore. Good thing there’s some oil literally propping up the foundations of both places….


That's one way to look at it. I've also been a long time critic of the GDP:public debt ration for a different reason. Public debt is not serviced from the general economy but from tax revenues. In countries with a larger public sector (an a proportionately higher tax rate), the ratio of revenue to debt gives a completely different picture than GDP to debt (which implicitly assumes that ALL private sector income is available as potential tax revenue, which is obviously untrue). Another problem comparing debt burdens is that EU countries have consolidated balances (all levels of government and contingent liabilities0 whereas in the US only the federal debt is considered, and the $Tr5-6 of liability in Freddie, Sally, Ginny, etc, are left out of consideration. Comparing the USA to Greece


Comparing the USA to Greece using the ratio of public sector debt to revenue puts the USA in worse shape. The ratio works out to about 600% in the USA, whereas in most European countries it is less than 300%. This is exclusive of US local and state government and the Freddy, Fannie, etc. It is axiomatic that debt is paid from income (tax), not from total revenues (GDP/turn-over).


Here are some numbers, albeit dated, but material nonetheless.