Misunderstanding The Nation’s Debt


McClatchy has published an article, Debt-limit friction a bad omen for tackling bigger crisis, which purports to explain the difference between internal and external debt and how that measures the seriousness of the current problem.

The article uses the following histogram to make some point. I am sure you are going to hear more about this chart in the coming days, so I thought I would give you a chance to try to figure out if there is any substantive meaning in it.


This graph raises more questions than it answers.  The graph is used by Alex Brill, an economist with the American Enterprise Institute, a conservative research center in Washington, which puts the whole thing into question right there. American Enterprise Institute, indeed.  The article also quotes Christopher Frenze, a former staff director of the American Action Forum, a conservative policy institute in Washington.

Greece, Italy, and Portugal are all countries that are considered to be on the verge of huge problems because of their debt.  They all have a debt as a percentage of GDP that is larger than the US.  However, Ireland and Spain are frequently lumped in with Greece, Italy, and Portugal as having problems, yet Ireland and Spain have lower debt to GDP ratios than the US.

Moreover, Japan, which is known to have very little external debt seems to have the largest ratio of external debt to GDP.  I looked up The Economy of Japan in Wikipedia.

For 2010 Wikipedia says Japan has GDP of $5.458 trillion, gross external debt of $2.2146 trillion and public debt of 225.8% of GDP.

So this works out to a gross external debt of 41.1% of GDP and a public debt of $12.324 trillion.  None of these numbers remotely correspond to anything in the chart used by McClatchy.

On second thought, the public debt of 225% from Wikipedia is in the ballpark of the 185% in the chart. Perhaps what OECD is calling external debt is what Wikipedia calls public debt. Perhaps this shows that no matter what you call it, the measure used in this article is not relevant as a measure of the seriousness of an economy’s immediate problems.

In analyzing private companies there is something known as the Quick Ratio. Investopedia provides the following definition:

Quick Ratio
An indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.

The quick ratio is calculated as:

Quick Ratio

Also known as the “acid-test ratio” or the “quick assets ratio”

Perhaps we need a measure such as this to look at the country’s financial situation.

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