Governments are addicted to eye-watering debt, never repaid. My firm belief that this is disastrous was wrong, so what changed my mind?
Before We Begin…
The terms, government deficit and national debt, are sometimes confused.
- A government has a deficit when it spends more money in a year than it collects in taxation. (If a government stays within its means (ha!), it has a surplus.)
- A national debt is the result of a government running a deficit for years, never fully repaying its accumulated loans.
This is not unfamiliar. Perhaps someone is only just getting by and suffers a run of bad luck. The washing machine breaks and then the car service costs more than expected. He or she has to put all that on a credit card, and can only afford to repay the interest.
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A new year begins with debt, and it gets even worse. The roof springs a leak, but luckily his or her credit is still good. The lender increases the credit limit and the roof is repaired. Belts are tightened, however, because interest charges eat into disposable income.
Could a Government Get A Mortgage?
The comparison between government debt and personal debt is alluring, but flawed. Although it gives us an idea of what’s happening, some pieces of the jigsaw don’t fit.
What do I mean?
For one thing, individuals have to evidence that they will eventually repay loans. If you apply for a mortgage in 2019, for example, you’ll be asked about your income, your monthly outgoings and any existing debt.
If you were like a government, you’d have to say something like this. My income is quite steady, but I haven’t been able to balance a budget for years. Actually, I never have, and – no – I’m not going to change my ways. Oh yes, I’m up to my neck in debt.
I wonder what the mortgage provider would say?
Surprisingly given that outlook, national deficits and debts are widespread amongst the developed countries (figure above). It’s not an aberration. How do governments get away with it? Why do they even want to get away with it? No one likes being in debt.
Money For Nothing and Votes For Free
The short answer is that loans offer an apparently painless, voter-friendly solution to tricky problems. Unlike taxation, no one seems to get hurt.
Left leaning governments have always been comfortable with debt, prioritising need over prudence. They are suspicious of (or even hostile to) the idea of Capitalism. The trouble, they say, with Capitalism is that mindless, amoral market forces decide who wins and loses, indifferent to natural justice.
The State with its moral compass should decide who deserves what. The needs of the many should outweigh the affluence of the few. Taxing the rich (sadly) only gets you so far, so borrow because it’s the right thing to do. Where all that borrowing takes you to is tomorrow’s problem.
Right Turns Left
Politicians on the right used to claim that they were conservative about debt. As Capitalists, they believed that markets are the uncomfortable Darwinian reality of life. People earned their fair share by hard work and thrift.
In the UK, Margaret Thatcher articulated that attitude:
Rather than piling up deficits for future generations to pay. We are repaying debts. Our budget is in surplus. We are lifting the burden off the shoulders of our children.
The Right, however, seems to have changed its tune. George W Bush, a Republican President, increased the US National Debt from US$3.3 trillion in 2001 to US$6.4 trillion by the end of 2008. Donald J Trump plans to add US$5 trillion to Natioanl Debt in his first term.
I’m not an admirer of Donald J Trump, but if he has a strength at all, it’s self preservation. He doesn’t see the colossus of the US National Debt (US$22 trillion in 2019) as being an imminent threat. On the other side of the pond, Boris Johnson (Britain Trump) is enthusiastically throwing money at any problem you care to ask about.
Debt is the new cool.
How could such towering statesmen be wrong? Is it right, to compare running a country with running a home (as Margaret Thatcher did)? Can we say with certainty that because large amounts of personal debt can ruin a life, colossal amounts of national debt will ruin a country?
The Right Sort of Debt
Well maybe, and I type that holding my nose (which is challenging). There is – wait for it – more than one type of debt and more than one type of debtor.
If you read my article, Money: The Great Confidence Trick, you’ll find out about capital. Capital, in financial terms, is money that is used to buy an asset that generates more money, so why not borrow capital to invest? That debt is potentially good if you get it right.
Governments (sometimes) borrow money to use as capital. If they build roads and bridges, for example, they employ people, who in turn spend money and grow the economy. That’s why some aspects of government spending is factored into Gross Domestic Product (GDP), one measure of economic performance. Government debt in this context is more like company debt than personal debt.
Contrast this with personal debt. Individuals rarely borrow money to buy things that increase their wealth. Usually, it’s the opposite. A loan is taken out to buy a new car, which falls in value the minute it is driven out of the showroom.
The exception to this is housing. A couple settles down to have children and takes out a mortgage for the family home. At some point in the future, the children leave, and the couple downsize. Usually house prices have gone up, so they make a profit. The couple are accidental capitalists.
Even Margaret Thatcher would admire borrowing to buy something that creates wealth. Debt can be good.
The Right Kind of Debtor
The apparently terrifying levels of debt facing most major nations might not be profligate and irresponsible after all. Over the years, decades and centuries, governments have sometimes borrowed money that improves economies in the long term.
That doesn’t mean we’re out of the woods just yet. Governments – just like people and companies – have to pay interest on their debts. In 2010, the UK decided that too much money had been borrowed and austerity was unavoidable. The Coalition Government cut back services, insisting that the UK had to live within its means. At the time, as a UK citizen, I agreed with that, because I didn’t believe in free lunches.
As it turns out, in the case of countries, I was wrong, or at least partially wrong. The rules are different for governments that control their currencies and money supply. The advantage that a government has over everyone else is that it can effectively create money from nothing.
Magicians or Fraudsters?
This bit gets a little mind-bending so get comfortable. We’ll discover that governments are borrowing from themselves and paying themselves back the interest as a profit.
When a government wants to borrow money, it issues bonds, which are effectively IOUs. They have a fixed term and pay interest. UK Government bonds are called Gilts. US Government bonds are called Treasury Securities. (Bonds are worth at least one article in their own right, but let’s keep it simple for now.)
Bonds are bought by large institutions. One particular type of institution can buy bonds: Central Banks. Central Banks (amongst other things), manage the money supply on behalf of governments. Let’s use the UK as an example.
The British Government needs to fund investment in schools, so it issues Gilts. The UK Central Bank is the the Bank of England, and even if no one else will buy Gilts, it will. (Actually, there are plenty of people who will lend money to the debt-ridden UK Government.)
Where does the Bank of England get the money to pay for the Gilts? It can do it in a number of ways, but one handy way is to. creates a credit to the UK Government’s account at the Bank of England. The government builds the schools and pays the Bank of England the interest rate on the Gilts. Jobs are created or protected.
The Snake Eats Its Tail
Now hang on a minute. Isn’t the Bank of England part of the UK Government? Well, it is… sort of. The Bank of England was established as a company in 1694. It was nationalised by the UK Government in 1946, so the UK Government is the Bank of England’s sole shareholder. Parliament gave the Bank independence in 1988, a decision of then Labour Chancellor, Gordon Brown.
It’s not totally independent, however. Its governor is appointed by the UK Chancellor, who also sets its goals. The Bank is free to set interest rates and the size of the money supply, but only to achieve goals set by the UK Government.
Unlike anyone else in the UK, the government owns a company with a Midas touch in the form of credit. The UK Government can never run out of credit when push comes to shove, because it can issue gilts that the Bank of England will always buy.
This inter-relationship between the Bank and the UK Government can have odd outcomes. The Guardian in 2012 reported that the Bank handed over Gilt interest payments to the Government, reducing the national debt. Think about that for a minute.
The United States manages its debts in an interesting way too. Just over a quarter of its debt (26.5% or US$5.8 trillion) is owed to arms of Federal Government. Social Security, for example, owns US$2.9 trillion of non-traded Treasury Securities because of a previous tax revenue surplus. The surplus by law had to be re-invested in Treasury Securities. The US Government is paying itself interest.
This all feels very liberating, doesn’t it? Don’t worry about debt. Credit is as good as money and can be created with the click of a mouse. Free lunches for everyone, but maybe there’s a risk of indigestion.
For a start, even if you can borrow freely, anytime you like, you still have to service the interest payments. Even with ingenious government accounting techniques (which would put the private sector in prison), there is still an interest charge, enlarging the deficit you’re trying to shrink.
The UK paid £48 billion of interest in 2018 (4% of GDP), and the US Government expects to pay US$593 billion in 2019 (just over 3% of GDP). That money cannot be used on schools or hospitals.
A bigger worry is that this approach to servicing debt links government borrowing to a country’s money supply. If government debt is small relative to a country’s economy, it shouldn’t matter. If a government continually runs massive deficits, trying to make that good by creating money causes damage.
Valueless Store of Value
The laws of supply and demand apply to money. The more plentiful a product is within a market, the lower its value. Money is a product that stores value. If there is too much money around, it loses its effectiveness and inflation looms.
Zimbabwe is a victim of hyper-inflation. In July 2019, inflation was running at 175.7%, up from 97.9% in May of that year. Consider that inflation was around 1.6% in the US and 2% in the UK. Even 175.7% looks good compared to Zimbabwe in 2008, when inflation was 500 billion per cent. That’s not a typo: 500 billion per cent. Zimbabwe was a wreck.
As of July 2019, inflation is not an issue in the West, in spite of the huge sums of money Central Banks have created to solve the 2008 Financial Crisis. In fact, Central Banks may increase the money supply.
Why is that?
It is thought that the normal effects of an increased money supply are being muffled by poor business and consumer confidence. People are paying off debt (or saving), taking money out of the economy. An inflationary time bomb may still be ticking.
Both the US and the UK governments (July 2019) are committed to extensive borrowing. The UK National Debt is 85.2% of its GDP, and the US National Debt is 106.1% of its GDP. They have lots of debt. If interest rates go up in response to newly emergent inflation, ouch.
We’re Indebted To Debt
Government needs debt.
Even given the dangers of just creating money, government debt (and even an ongoing deficit) is not as bad as my conservative upbringing made me fear. If a government borrows to invest, injecting life into an economy, it can kick-start growth.
It is also true that public sector employees form a significant proportion of most economies. Ensuring that they remain economically active also boosts an economy. For some countries, this is the right thing to do.
Other countries, however, have already played the borrowing card many, many times. What is difficult to predict is when countries such as the US and the UK will gamble one too many times.
More on economics:
Debt depends on money and debt, but what if money is a confidence trick Find out here .
Tariffs are increasngly popular with governments such as the USA. Who do they really hurt? Find out here .