Is Rising U.S. Debt Inviting Trouble? Ask Japan

U.S. Dollar
U.S. Dollar

As Europe's debt woes play out in a disturbing fashion, investors on this side of the Atlantic are wondering if the same thing could happen in America. With a public debt to GDP ratio of 90% and climbing, the U.S. isn't so far behind Greece's 115% mark, after all.

And there's no shortage of high profile doomsayers on this front, either. Harvard historian Niall Ferguson, for example, has long warned that Greece is a preview of things to come in the U.S. A celebrated new book by Ferguson's colleague Ken Rogoff, an economist, warns of the inevitable dangers that come with mounting government debt.

Investors would be wise to take a more levelheaded approach, though. Sure, there are a handful of similarities between Greek and American circumstances. But evaluating the risks that public debt poses is a highly complicated proposition not easily boiled down to a few correlations. And the best illustration of that may be the surging popularity of the Japanese yen, a currency that rallied sharply in the wake of European debt jitters.

Like All Else, Economic Problems Are Relative

The irony, of course, is that it's hard to find a more egregiously indebted economy than Japan's. The country sported a debt to GDP ratio of 192% last year, according to the Central Intelligence Agency. Yet investors fleeing the euro took refuge in the yen nonetheless.

Despite Japan's towering debt, investors have good reason to see the yen as a safe haven currency. Much of Japan's debt is internally funded, and domestic savers have plenty of incentive to park their cash in government securities like bonds given the deflationary environment, where their purchasing power is likely to rise over time.

Japan also has an orderly political and administrative apparatus for resolving disputes between parties. The value of this was on full display during the tense German and Greek standoff that provided the backdrop to the current crisis. Along with being greatly reassuring to investors, this can also have a direct impact on the bottom line.

Some estimates put Greek government losses because of tax evasion at $30 billion a year, for example. The budget cuts under the austerity measures that Greek just accepted -- the ones that led to widespread rioting and death -- amounted to about $38 billion. Just having a working tax system, in other words, would have played a major role in alleviating Greece's woes and highlights the differences with other advanced industrial economies like Japan.

Broader Perspective Is Needed

Then there are the benefits of having your own currency and central bank. Being locked into the euro means that Greece is unable to devalue its currency independently. A gut-wrenching process of wage cuts and deflation will likely have to play out before the country can be competitive on the international stage again. Any signs that Greece was considering exiting the euro, meanwhile, may be even more disastrous and lead to a run on its already shaky banks.

Despite all the alarm about U.S. government debt loads, then, investors need to put the American position in a broader perspective. And as the rally in the dollar and yen amid European jitters show, the situation here isn't all that terrifying when those factors are taken into account.