$60 trillion and counting… When does government debt become a problem?

Sascha: [00:00:35] From Equity Mates media. This is the dive. I'm your host, Sascha Kelley. I don't know about you, but I've heard a lot of these headlines.

Audio clip: [00:00:43] Total worldwide debt has never been higher. The government has just raised a loan of $50 billion. That's added to the existing debt of $700 billion. 

Sascha: [00:00:54] By the time I introduce this episode, the U.S. alone will have added $1 million to their national debt. That's $1 million every 40 seconds. And did you hear that? That's $100,000. And the global debt, the sum of every country's national debt combined is over 65 trillion. That's 12 zeros. If you ever needed to write it on a check. So why do I keep hearing economists on the news telling me 

Audio clip: [00:01:24] Debt is Not something that. The general public should be worrying about. 

Sascha: [00:01:27] That we shouldn't think of debt in the same way that I think about my credit card and my mortgage. That the discussion about debt and deficit is more politics than it is economics. So when Sri Lanka recently started to default on their debt, that had me wondering, have these economists been having us on? What's different for Sri Lanka? Is there a point where we should stop worrying about government debt? It's Wednesday, the 27th of April. And today I want to know when does government debt become a problem? To do this, I'm joined by my colleague and the co-founder of Equity Mates Alec, Renehan. Alec. Welcome. 

Alec: [00:02:03] Thanks, Sascha. That's another $100,000. 

Sascha: [00:02:07] That's going to be how I answer all my questions from now on. Government debt. Tell me why I should care. 

Alec: [00:02:13] Not the most interesting topic, but it is an important topic. Let me tell you about my favourite government debt story involving the Argentine warship, the Libertad. 

Sascha: [00:02:23] This is going to be a pub anecdote for years to come. I could just tell.

Alec: [00:02:27] The American hedge fund Elliott Management bought the debt of Argentina after it defaulted in the early 2000s and then spent the next decade trying to seise Argentine assets in 2007. They almost seised Argentina's presidential plane. But then in 2012, Eliot management found out that the Libertad, an Argentine warship, was in Ghana. And Eliot management got the warships seised with a crew of 220 naval personnel on board. Really brings a whole new meaning to the term corporate raider. 

Sascha: [00:03:01] Sounds like a real world version of battleships. 

Alec: [00:03:04] I mean, a hedge fund with a military warship, like we just have to acknowledge that's a pretty remarkable story. 

Sascha: [00:03:10] Okay. I'll admit that that is interesting, but I'm still not convinced that that's just not a one off anecdote and that government debt in general is a topic that I'm going to be excited about. 

Alec: [00:03:20] So for most people, government debt won't affect their day to day lives. If anything, the higher the debt, the higher the government spending today, which means government spending on more programmes and it might affect their lives in that way. But really, the debt itself, how the government borrows money from international credit markets isn't something we think about a lot. But while it may not affect our day to day lives, when a government defaults on their debt, it can be catastrophic. 

Sascha: [00:03:46] So what I'm hearing you tell me is that I really shouldn't care until I should care, at which point I'll probably find out about it. 

Alec: [00:03:55] Yeah. You shouldn't care until it's the only thing you care about. It doesn't matter until it's the only thing that matters. But the trouble is, it can be confusing when to be concerned because there's so much political noise out there. Debt and deficit is a catch cry we heard in Australia over in the US. Opponents of racking up more national debt literally put a clock above Times Square. Counting up the debt clock was put up in 1989. 

Audio clip: [00:04:22] When the national debt was just. 

Alec: [00:04:24] Under $3 trillion. It stood there for a while. The building then got knocked down. But we wanted to cut through the political noise and understand it as an economic issue because the numbers are staggering. As you said in your intro. Over 65 trillion in government debt around the world. The US leading the way with over 30 trillion in government debt. But the UK has around 3 trillion. Even Australia has over 1 trillion. And yet Sri Lanka, a country with a similar population to Australia, has just defaulted with a government debt of less than 50 billion. 

Sascha: [00:04:58] Breaking news coming in. 

Audio clip: [00:04:59] From Sri Lanka. The country has announced that. 

Sascha: [00:05:02] It is defaulting on all its external debt. That is the confusing part because these numbers, they're so large, it almost feels abstract. Sir, help me understand the context of what's happening in Sri Lanka. They've just entered what's called selective default. What does that mean? 

Alec: [00:05:20] Selective default is essentially the step before a full default. It's when the borrower, in this case, the Sri Lankan government, fails to pay some of their debt obligation. But. Continues to meet. 

Sascha: [00:05:32] Others. So I'm paying my mortgage, but I've stopped paying my credit card. 

Alec: [00:05:37] Exactly. And in this case, the government has about 51 billion U.S. dollars in foreign debt. And this week, Sri Lanka failed to pay 78 million in repayments and interest on two particular bonds. Now, this led to the three big credit ratings Fitch, Moody's and S&P to all agree Sri Lanka was in selective default. And Sascha, unfortunately, things don't look like they'll get better from here to Lanka. 

Sascha: [00:06:04] I think its. 

Audio clip: [00:06:05] Worst economic crisis since its independence.

Alec: [00:06:07] The government is due to pay $7 billion in debt repayments and interest by the end of this year. A $1 billion payment is fast approaching in July and Sri Lanka simply doesn't have the foreign currency to pay foreign reserves. The amount of U.S. dollars, British pounds euros that Sri Lanka holds were down to $1.9 billion by the end of March. 

Sascha: [00:06:31] So how does this happen? Sri Lanka, as you said, is a big country. They have smart people. How do they get themselves into this situation? They must have seen these numbers coming. 

Alec: [00:06:41] The origins of this crisis stretch back to 2019, when the Sri Lankan government offered a big tax cut to get re-elected.

Sascha: [00:06:48] And we all know that tax cuts are great in election time. 

Alec: [00:06:51] Well, it worked. The government got re-elected, but it did reduce the amount of money coming in to the government's coffers, which reduced the amount of money they had to pay back that debt. Then COVID hits in 2020. And two of Sri Lanka's biggest sources of foreign currency, tourism and remittances dry up. And then, Sascha, a final brutal factor. Last year, the Sri Lankan government imposed a nationwide ban on synthetic fertilisers and pesticides, ordering the country's 2 million farmers to go organic.

Audio clip: [00:07:24] Farmers across the country have been protesting the shortage of chemical fertiliser since the government banned imports in May. 

Alec: [00:07:31] By November last year. This ban was lifted but the damage was done. Since then, Sri Lanka's currency has declined more than 30% against the US dollar, meaning Sri Lankan people's purchasing power is lessened. Just as prices are soaring. 

Audio clip: [00:07:45] Here's an idea of how much basic necessities now cost. White rice, a common Sri Lankan staple, increased by 93% since 2019. Chicken and lentils have gone up by at least 55 and 117%, respectively. The state owned Ceylon Petroleum Corporation raised the price of fuel by more than 130% last week, and a standard household cylinder of cooking gas increased from almost $5 in 2021 last year to $9 this year. 

Sascha: [00:08:17] So essentially the power of their money has lessened because they can buy less for the same amount that they could previously and at the same time, food, essential items. Those prices are skyrocketing. So I can see how this is a bit of a recipe for disaster. Yeah. 

Alec: [00:08:32] And in particular, they were running out of foreign currency and because a lot of their debt was in foreign currency, in US dollars, mainly they needed foreign currency to pay back that debt. And this month, the government chose to stop paying interest on that debt to keep the foreign currency left, to import food and fuel and other essentials. So, Sascha, we're in a situation where interest payments account for 95% of government revenue and Sri Lanka simply cannot pay back that debt. 

Sascha: [00:09:03] 95% of government revenue. That is massive. 

Alec: [00:09:06] It is massive. And it's got to the point where the governor of Sri Lanka's central bank has appealed for donations from Sri Lankans living abroad for pound sterling U.S. dollars and euros. 

Sascha: [00:09:18] I imagine that if 95% of your government revenue is being spent on interest payments, what's happening to the country of 22 million people? The effect can't be good on them.

Alec: [00:09:29] Sri Lanka's economy is in crisis and there's a real human toll that's being taken.

Audio clip: [00:09:34] After months of economic hardship, the crisis has only gone from bad to worse. 

Alec: [00:09:39] Food and fuel have been in short supply for weeks. There are power outages of up to 13 hours a day in some areas, which have crippled businesses and shut down the economy. School and university exams have been postponed due to lack of paper. Hospitals across the country are running out of essential medicines. The situation is incredibly dire and it's only getting worse. 

Sascha: [00:10:03] There is a some really sobering statistics, and I think it really paints a very real picture of the effects that these people are suffering as a result of what seems like an abstract government debt conversation. Let's take a quick break and we'll be right back in a moment. Before the break, we talked about the news out of Sri Lanka. But the big question we set out to answer today was what separates the debt of different countries? Why does Sri Lanka default? But Australia, a country of similar population size, continue to grow their debt. And to do that, Alec, you sat down with Thomas Keily, our chief economist here at Equity Mates Media and one half of the smash hit Comedian Buzz Economist's podcast. Let's go to that conversation now.

Alec: [00:11:31] Thomas, thanks for joining us today. Nice to be here. On Canadian The Economist this week, you and Adam covered off some of the Sri Lankan debt crisis stories. So if people want to hear more, they should go and listen to Canadian The Economist. But I guess we wanted to ask the bigger question here, the question that Sascha and I are trying to tackle in today's episode, which is when should we worry about a nation's debt? Seems every country with covered has borrowed more and spent more. When should we actually be worried about national debt? 

Thomas Keily: [00:12:02] It's a bit of a funny one because it does come down to a just a bit of vibe in the credit markets. So Sri Lanka sort of run into trouble right now because the vibe shifted and no one thinks Sri Lanka can pay back its debts. And so it's frozen out of credit markets. It can't rollover its debt to that axis any more credit. There's no sort of hard and fast rule about when that vibe shifts. It's just a general perception of when they're no longer able to pay. And so that's so that's sort of part of it. So that's one of the reasons why there's no sort of definitive answer or definitive metric of a debt to GDP ratio that you can give, because it just depends on sort of the vibe to some extent, the sort of two things to think about. One is the debt mix, and then one is the denomination of the debt. So with the debt mix, you think about like someone with a half a million dollars mortgage debt where they're paying 3%. They're in a very different situation to someone with half a million dollars of credit card debt where they're paying 17%. And so often when we're talking about debt, we're talking about the debt to GDP or the absolute level of debt. But really the mix matters. So is the duration like how long is the debt for? So that's one thing that's hit Sri Lanka is that people are willing to lend for as long to Sri Lanka. So that duration shortening like 60% of the debt under ten years now. So people want their money back more quickly and the rates have been increasing. Whereas you know, in Australia we're paying zero point something, the Federal Government's paying zero point something for their debt. In Sri Lanka they're getting up to sort of six and 7% before credit markets froze them out. So that debt mix was really starting to work against Sri Lanka that had cheap debt. But then they started as they got more into trouble, they started rolling that cheap debt out for more expensive debt. It's a bit like moving from mortgage rates to credit card rates, and then that increases the interest burden, which then means you've got to take out more debt and you end up in a bit of a spiral dynamic. And that's when you that's when you get into trouble. 

Alec: [00:13:58] As your economy gets worse, your interest rate gets higher, but your economy is worse. So you're less likely to be able to afford the interest rate, it seems like. Yeah, once you're in that spiral, it would be hard to get out of it. 

Thomas Keily: [00:14:08] I can't think of an example with a country that's got into a situation like Sri Lanka's in where they're going to the IMF and needing help to restructure their debt, where they've got out of it in less than three or four years. You know, that's kind of the best case scenario for Sri Lanka now, and that probably involves quite a lot of pain along the way. 

Alec: [00:14:25] So that's debt mix. You also mentioned denomination of debt. What's the vibe we should be aware of there?

Thomas Keily: [00:14:30] Probably the big thing is will currency your debts denominated in? So like in Australia, all of our debt, that's the Federal Government issues is issued in Australian dollars. So that's a nice situation to be in for the Australian Government because the Australian Government also has the ability to print Australian dollars. So there's no practical path to default in that story because as you rack up debt in Australian dollars, you can just print more dollars to pay off that debt. That might have consequences for inflation or other consequences. But just in terms of your ability to carry your debt burden because you have that ability to print Australian dollars, you're never going to get into trouble. Sri Lanka is in the situation like a lot of sort of middle income countries and developing countries where they're issuing the bulk of their debt in US dollars. That can get you into trouble because currency exchange rates fluctuate like right now in Sri Lanka. I think the rupee's devalued by 50% over the since the start of the year or something like that. That means that your interest payments are still due in US dollars. So as your currency devalue the amount of money you've got to create to pay off your interest, that starts to go up and up and up. And then we get another is another spiral dynamic there that as people sort of start to realise that your economy's in trouble and you're heading into a debt crisis, your currency devalues even more, which pushes up your interest rate burden even further. 

Alec: [00:15:53] So I guess the question that comes out of that is Australia takes most of its debt. In Australian dollars. The US takes most of its debt in US dollars and they can print more of those currencies. Sri Lanka has 65% of its debt in US dollars. Why is that the case? Why didn't Sri Lanka only borrow in rupees? 

Thomas Keily: [00:16:13] It's just the nature of international credit markets. And because it's sort of a credit risk. Like if you imagine being a lender to Sri Lanka, if they're like, well, I can lend in rupees, but I don't know what's going to happen to the ₹2. I don't know if I'm going to get my money back, if I've sourced my capital in US dollars. Like that's the money that I'm working with. I need to guarantee a return relative to those US dollars. So those lenders would go to Sri Lanka and say, Look, I can lend to you in rupees, but I'm going to need a much higher interest rate to compensate me for the exchange rate risk. Or I can give you a lower interest rate, but you've got to commit to paying back in US dollars and you share the exchange rate risk. And that's sort of the situation where the Sri Lanka's increasingly come to where lenders are going to. No, we're not willing to where that exchange rate is going to push that back onto you. So I'm going to lend to you only in US dollars. 

Alec: [00:17:01] I guess the flip side of that question is a country like the US that takes its debt in US dollars or Australia takes it in Australian dollars when they have access to a money printer and they can print their own money. Can a country like that ever actually have a debt crisis? 

Thomas Keily: [00:17:16] Not in the short term. They can always print their way out of trouble. At some point, though, markets are going to go like this. You're devaluing your currency here. If you're sourcing your capital from international money markets, they're going to say, oh, there's an exchange rate risk here because you're printing so much money, you're going to start devaluing your currency. Therefore, I'm going to need to push that exchange rate risk back onto you. So like Australia at the moment, we don't the exchange rate risk is minimal because the Australian dollar moves in a fairly narrow band and there's no real prospect in the short term that it's going to collapse. 50% that would be unheard of. Yes. So in the short term, no, but in the long term it does have consequences and credit markets would be watching and keeping an eye on. And at some point we go, okay, now Australia, we're cutting you off. We're only going to issue debt in US dollars now.

Alec: [00:18:03] Okay, we're in a better position here in Australia, but we can't just take the foot off the brake or off the gas. I don't know where this analogy is going. We can't just completely relax because over the long term there could be some impact. 

Thomas Keily: [00:18:15] Yeah, that's right. That's right. 

Alec: [00:18:17] So, Thomas, I want to thank you for joining us today. Thank you for sharing your insight. And if people want to hear more from Thomas, they should head over to the Comedian v Economist podcast and hear him and his brother break down the world of macroeconomics. 

Sascha: [00:18:30] I like I'm so glad you brought Thomas on the show, because every time I hear him talk, I learn something new. But at the start of the episode, we set out to understand when a government debt becomes a problem. 

Alec: [00:18:41] As with a lot of things in finance and economics, there's not an easy answer. It's so dependent on the context and dependent on the whims of the market. As Thomas explained in this case, the market wasn't willing to lend to Sri Lanka, and then that really set the tone of what came next. So should we worry about 30 trillion in the US, 3 trillion in the UK, 1 trillion in Australia? I think we can say that there are some unique circumstances in Sri Lanka that don't apply in a lot of other countries with a lot of debt.

Sascha: [00:19:14] Thanks so much for joining us for today's edition of The Dive. If there's a story that you'd like us to talk about, then contact us the dive at Equity Mates dot com or shoot us a message on social media. As always, those links in the show notes below. If you loved the sound of Thomas, then go and check out comedian, Buzz Economist. They have a new episode every Wednesday morning and we're going to be back in your feed later this week. Thank you so much for joining me today, Alec.

Alec: [00:19:40] Thanks, Sascha.

Sascha: [00:19:40] Until next time