Monday, November 21, 2011

Money Management 101...same rules apply for countries as individuals!

Let me begin with some observations on the basic mechanics of sovereign debt default management, or to the average person, balancing ones budget.  If you borrow $1 at a 5% interest rate, next year you're going to owe $1.05.  If you don't pay any of it back and just roll over the debt, you'd then have to borrow $1.05 next year and on and on and on.  This is obviously a slippery slope, even if it's a sovereign government doing the borrowing.
Though the previous example seems obviously wrong, countries and individuals alike often justify the continued borrowing based on increasing incomes or increasing GDP.  If a country's GDP growth rate for example, is higher than the interest rate they borrow at, then the debt they owe, although growing, would still shrink as a percentage of their GDP.  But if GDP growth is below the interest cost, then the debt that's continually rolled over would grow to become a larger percentage of their GDP.  As soon as lenders recognize that's where the country is headed, the government is going to find it much more difficult and expensive to borrow the necessary new sums of money needed to fund the country and it's debt burden.
To prevent this from happening, government and individuals need to run a budget surplus, meaning that tax receipts or income must exceed expenditures.  In doing so, a portion of the surplus can be used to reduce the debt, avoiding the downward spiral faced by a number of countries and individuals around the world today.
According to ECB data, Greek government debt was already 120% of GDP in 2008.  The budget deficit was over 10% of GDP in 2009 and almost 5% in 2010.  That, plus the rapidly increasing interest rate costs (higher risk, higher cost) facing Greece, pushed their debt to 156% of GDP in 2010.
If Greece were an individual coming to you for a mortgage, I'm guessing they would be hearing "declined" and put on a serious debt counseling program!

 Compliments of:

The Content Team
GoMax Solutions Inc

No comments:

Post a Comment