This was the week the debt merry-go-round jerked and lurched and the whole world got nauseous.
Greece, which hit its debt wall years ago, once again took Europe to a precipice. Whatever the outcome of Sunday's "final deadline" for a deal with its creditors, Greece is a goner, sadly. How much damage it does to the rest of the world remains to be seen.
Greece's fate could also await Puerto Rico, whose governor suddenly declared that the $72-billion (U.S.) debt the U.S. territory in the Caribbean has racked up is "not payable." That somehow came as a shocker to bondholders who had been breezily plugging coins into the island's debt merry-go-round.
Then there's China, whose debt-induced stock market bubble continued to deflate despite the Communist regime's best efforts to defy the capitalist laws of gravity. It may take another Chinese miracle to contain the fallout caused by amateur investors who bought stocks on margin.
Amid these bone-tingling examples of the consequences of borrowing beyond your means, Ontario Finance Minister Charles Sousa managed to put a happy face on his province's credit downgrade by Standard & Poor's. The debt-rating agency now considers Ontario, once the country's mighty economic engine and still home to nearly four in 10 Canadians, no more creditworthy than demographically challenged New Brunswick or Quebec.
Ontario is "a sustained and projected underperformer on its budgetary performance and debt burden versus domestic and international peers," Standard & Poor's said in slicing the province's credit rating to A-plus from double-A-negative. The province "has been slow to fully roll out the spending controls and revenue measures needed to eliminate its structural operating deficit, which has caused its tax-supported debt level to approximately double since fiscal 2008."
The typical response to such warnings is that Ontario is no Greece. And while that is true, the sharp deterioration in the province's fiscal situation combined with its weaker long-term economic growth prospects suggests Ontario's "safe" debt limit is much lower than it was, say, a few decades ago. Indeed, the recent run-up in its debt has occurred just as Ontario's ability to support it has declined. That should be more than a casual cause for concern.
As Greece found out, you discover your true debt limit only when the merry-go-round stops. That is the moment you can no longer roll over your debt, or you can do it only at punishing interest rates.
A new study from the Organization for Economic Co-operation and Development sets out "prudent" debt targets for its 34 member countries that vary depending on the ability of each to service its debts and respond to economic shocks.
For rich countries with their own currencies, gross public debt can have detrimental effects on economic growth once it reaches a range between 70 and 90 per cent of gross domestic product. But for euro-zone countries, which do not control their own monetary policy, the debt threshold is much lower, between 50 and 70 per cent of GDP.
"However, the debt limit is a moving target as it can be reached quickly, if a country loses market confidence or if macroeconomic conditions change sharply," the OECD study notes. "Therefore, any debt target should be lower than such debt limits as uncertainties surrounding the underlying hypothesis (e.g. on long-term growth rates) and the risk of interest-rate spirals call for a substantial buffer."
As a subnational entity without its own currency, Ontario resembles a euro-zone country more than a true sovereign borrower. Its debt limit should reflect that. At more than 39.8 per cent of GDP, Ontario's net debt (the preferred debt measure of Canadian governments, which is typically several percentage points lower than the gross debt targets the OECD uses) may not put the province in the danger zone. But it is surely close. And it would not take much, perhaps a mild recession, to put it there.
Even if Mr. Sousa makes good on his promise to balance the budget by 2018, Standard & Poor's notes that the province will continue to "contend with very sizable yearly after-capital deficits" as it carries out its $130-billion infrastructure plan. In a perfect world, borrowing for infrastructure would be considered good debt if all the money was spent on productivity-enhancing roads and transit rather than on vote-buying schemes that turn out to be white elephants. It is a safe bet some of the latter is in Ontario's plan, such as the Scarborough subway extension.
Mr. Sousa can get away with that as long as the debt merry-go-round keeps turning. But as this week shows, you can never tell when it will stop.