The Next Bubble is Public Debt

While the world economy is heading for recovery, many are trying to locate the next bubble in asset markets: Will it be in the gold market? Will it be in Chinese Real Estate? Or might it be in emerging markets. The answer is no to these questions according to Kenneth Rogkof, a professor at Harvard University, as the public debt is the next bubble. In the case of the Greek crisis, some analysts wonder how a country has managed to present for many years, a public debt above 100% of its Gross Domestic Product and suddenly faces danger of bankruptcy?

The answer lies in the fact that the size of government debt is accompanied by interest payments. As big as the ratio of debt to GDP might be, if the interest payable by a government are low and GDP is supported by a fast growing economy, then the situation remains under control. In fact, a heavily indebted government can afford to not pay a “premium” for wastage, for as long as it’s accelerating pace of economic growth and interest rates remain low.

Greece and other countries with high debt for many years benefited from such favorable conditions. This balance, however, can prove very fragile and disrupted by three parameters: GDP growth slowing down, interest rates rising or a country showing a deficit. In the case of Greece, the country has been presented all simultaneously, feeding a “vicious circle. And if the country is forced to pay a premium of 6% instead of 4% and the contraction of the economy, coupled with the implementation of austerity measures have a negative impact on GDP growth. This is a real “tour de force” followed by a huge political cost for a country that historically showed deficits.

And the real challenge for investors and economic officials are identifying large and systemically dangerous deviations from economic fundamentals, differences that make threats to financial stability and price stability. And very often the actual size of government debt remains “silent”, and might come to light after a crisis.