Is There a Government Debt Problem?
Federal debt in most industrialized countries has increased quite a bit since 2008. Is this a problem going forward? Lets dig into this a bit…
Lets start with the US debt-to-GDP ratio 1960–2019:
Obviously, it exploded due to the last financial crisis, which decreased tax income and increased government spending. Throw in the general detaxation of the Trump Administration plus increases in spending, and indeed you get a lot of debt due to repeated deficits (deficits are the annual shortfall, while debt is the accumulation of deficits over the years).
Is this a problem? Well, one measure that matters is how much interest you must pay on your debt. Here is that measure, as a percentage of GDP, for the USA:
Roughly the same level as the 1960s as it currently stands now, and probably will decrease, because I expect interest rates to drop after 2020…
Here is household debt-to-GDP at average long run interest rates, in other words, a proxy for the household “debt service” in % of GDP for the USA:
Lowest in decades! (the data series cuts beyond 2004, but it’s the same message).
So? Is government debt a problem? Short answer: no!
IF interest rates increase, THEN it would become a significant problem, because even small interest increases on a large debt (in % of income) could be problematic. But interest rates increase only if inflation increases, which is not about to happen! Add to this fact the incredible flood of emerging market savings keeping the global real inrerest rate low (“r*”), and you understand that the risk of an abrupt increase in interest rates is close to zero!
Hence, government debt is not a problem for now and for several years to come.
Take Japan, with the highest debt-to-GDP ratio in the world… what is their “debt service” load? Here is my proxy:
It’s never been lower!
There is NO government debt problem in all industrialized countries!
What gives? Is there no price to pay? We can just build up debt without consequences?
First, high debt is not necessarily a problem: if I am a poor student of neuro-science and I currently earn 60k/year as a student-intern, but WILL earn 500k/year as a brain surgeon, a debt of 200k may seem a lot now, but it’s not: if you have future income to cover your debt, then you have no real problem.
Future income to cover government debt can come from higher taxes OR higher economic growth. Given the structural forces at play, perhaps it’s more likely to become higher taxes. For the USA, this is not much of a problem, because taxes are generally low, so there is space to increase, but it’s not politically profitable.
If it’s not future growth or future tax hikes or major government spending cuts, then what can it be? The other options are:
- Higher inflation: you “print” money to pay for your debt, and the printing party causes inflation to increase significantly. This is what I call “implicit default”: you repay as promised, but what you repay is worthless.
- Currency debasement: if foreigners hold lots of governement debt and the debt is denominated in your own currency, a currency depreciation will do the trick as well, and this kind of goes with inflation: you repay the nominal amounts due, but the purchasing power of the amounts paid has decreased due to “currency debasement.” This is what I call “implicit default”: you repay as promised, but what you repay is worthless.
- Default: you don’t pay part or all of the debt. This creates a panic in financial markets and can get ugly, but the crisis eventually passes.
- Eternal stagnation: if you don’t “purge” your debt with default or inflation or currency depreciation, THEN you draaaag that debt along with you forever. That forces the country to keep interest rates super low, because any increase of rates crashes the economy due to the huge and fast effect on the debt service. This then floods the market with unproductive capital and makes savings eventually worthless, as asset prices reach stratospheric levels that have limited upside and returns on savings go to near zero. This is Japan (and I think soon the Euro Area).
The 4th option is what most every country is coming to as a “default” option (pun intended). This breeds frustration and social tension, but it holds things together… until they fall apart. Eventually, you get either inflation OR a negative shock that plunges the economy into deflation, which then causes “debt-deflation” dynamics, which typically ends up in a default purge anyways. You can also build social tension due to eternal stagnation, which can bring about political tension and problems.
But for now and as long as markets will think “at the margin” and not so much in the big picture, government debt is not a problem.
Of course, in the long run, there is an obvious issue: all countries of the industrialized world will have stagnation issues, as I explained in “Slow Decade Ahead”:
USA annual growth rate 2000–2020: flat at 2%, with LOTS of fiscal and monetary stimulus:
Canada annual growth rate 2000–2020: barely 2% and trending down.
Eurozone annual growth rate 2000–2020: barely above 1%:
Japan annual growth rate 2000–2020: barely 1% with LOTS of everything-stimulus:
UK annual growth rate 2000–2020: below 2% and trending down:
China: strong growth above 5%-6%, but still trending down 2000–2020:
Eventually, we’ll have to deal with reality, which is that the norm is trending towards grinding slow growth. Meanwhile, we can print and spend… as long as inflation remains in check, it’s all good!
Pascal Bedard
pbeconomiste@gmail.com
