Sovereign debt and size

There seem to be a strong correlation between the size of countries and the amount of debt they can acquire before their interest rates start spiraling out of control. Most people seem to imagine some 100% of GDP threshold after which a countries debt burden becomes unsustainable. This number seems about right for most troubled European countries. But looking at the massive Japanese economy it is completely off. Their debt to GDP ratio is closer to 200% of GDP yet their borrowing costs are the lowest of any country. This size theory helps when it comes to understanding the ease at which America can borrow. The American public debt burden is large and more importantly growing. Yet they can borrow at almost no cost.

This size debt tolerance relationship can likely be explained by a bigger bond market being less affected by a group of worried investors selling their bonds.

This relationship is also something we should keep in mind when considering the effect of the much debated euro bond. It is usually thought of as a way to drive down borrowing costs by sharing the risk with countries with less debt. Mainly benefiting from Germany's thrifty ways. But the size relationship should imply that there is also a benefit in a larger economic base. This is supposedly something that even more responsible countries like Germany could benefit from, or at least help mitigate some of the harm done by having to guarantee the debts of their less well behaved neighbors.