“There are people who think we have nothing. All these difficult decisions have to be made to deal with our debt. . . . It’s as if they think there is a magic money tree. Well, let me be clear, that is not the case. ”— David CameronUK Prime Minister, 2010-2016
What impact will public debt have on the long-term potential of the economy?
Ten years ago, some economists argued: Public debt of over 90% of GDP led to negative growth. Others disputed these parameters, but acknowledged that developed countries with public debt exceeding 90% of GDP averaged 2.2% annual growth from 1945 to 2009. 4.2% for companies with a ratio of less than 30%.
Whatever happens Relationship with sovereign debt Many developed countries have debt burdens well above the 90% threshold.
Britain’s debt-to-GDP ratio was below 80% when then-Prime Minister David Cameron stressed that further deficit spending was out of the question. After 10 years of training Alchemy money tree, its number is now 100%. In the United States, after 40 years of nearly uninterrupted supply-side conditions,trickle down economics,” this The ratio is 120% or more.
What if governments decide to end this permissive environment and start deleveraging?
1. redemption
Governments can forgive public debt by selling infrastructure and other state-owned assets. For example, Greece sold some of its holdings after the Eurozone crisis in the 2010s. airport and seaport and Has a large stake in telecom operator OTEto eliminate some of the liabilities, among other assets.
The state can also requisition the assets of citizens and companies. In the 16th century, Henry VIII dissolved the monasteries of England and disposed of their properties for military purposes. During the French Revolution, the Constituent Assembly confiscated and auctioned the clergy’s property to cancel public debt.
However, taxation rather than outright expropriation is a much more common appropriation technique, even through higher marginal income and capital tax rates. Proposed by the Joseph Biden Administrationor through exceptional taxes.
In the United States, some economist and politician Support a wealth tax to address economic inequality and generate additional income to pay off debt. In the UK and other countries that have not yet overhauled their property laws, Taxing land values is a viable option.
Of course, with globalization and radical financialization, tax evasion and tax avoidance schemes are becoming more and more sophisticated. Without international cooperation, wealth tax collection will not be easy or fair.
2. Pruning
A more effective debt service strategy is to increase prices. Inflation mechanically lowers the debt-to-GDP ratio as the denominator expands while production and government revenues rise. For example, in the aftermath of the oil shocks of the 1970s, US Public Debt Falls from 35% to 30% As a percentage of GDP.
If interest rates remain below the price index, not only will the value of the principal fall, As has happened in many developed countries over the past 18 months,, Negative real interest rates reduce the debt service burden. In situations where inflation is in the double digits or close to it, interest rates are in the low single digits, making interest payments much easier to manage.
Unsurprisingly, retail price index-linked bonds account for about 25%. UK public debt, does not provide such comfort.U.S. Treasury Department First issue of government-guaranteed inflation-indexed bonds in 1997 — at a time when many thought inflation would be permanently under control — but I paid them nearly double digit interest last year..
If maintaining zero or negative interest rates in real terms is the standard method of financial repression, current conditions show that inflation is difficult to control, while the 1970s scenario It shows that the reduction of sovereign debt due to inflation will take time. Either way, such arrangements are harmful to savers and consumers alike.
A currency devaluation can also reduce debt service costs. It has been unofficially recognized by the UK since it left the European Union. Through such depreciation, a country that issues public debt in its own currency facilitates the redemption of that debt. Since interest payments on government bonds are mainly fixed,.
Budget deficit reduction is even more effective. Government spending cuts and revenue increases ultimately create budget surpluses. This is what the Cameron administration was trying to accomplish during the Great Recession.
However, success is not guaranteed. Such efforts require phasing out popular programs and maintaining fiscal discipline, which may take decades to bear fruit. In the last 50 years, the U.S. has been in the black for only four years.. France last reported a balanced budget half a century ago.
A less painful way to reduce public debt is for borrowers, whether individuals, businesses or nations, to expand their debt structures. But stimulating growth is no easy task. Over the past 30 years, Japan has Debt to GDP to 220% from 40% in the early 1990s again more without today Producing the expected economic expansion.
Getting out of debt is difficult and nearly impossible if central banks maintain tight monetary policy amid inflation fears.
3. Fix
Restructuring may be a more reliable way to manage sovereign debt. “Independent” central banks bought government bonds to sustain the economy throughout the 2010s and resorted to more unconventional monetary policy during the pandemic.
Since the global financial crisis (GFC), US Federal Reserve balance sheet expanded eightfold on the other hand 7 times that of the Bank of Japan. This debt abolition strategy lowered interest rates to zero and the cost of debt evaporated.
Instead of flooding the public market with sovereign bonds, the government chose to temporarily store government bonds off-market. However, post-pandemic contractions have resulted in Central Banks Offload These Bonds.
Creditors may also voluntarily waive their right to redemption. So-called debt forgiveness was common in ancient times, but no such debt forgiveness has been practiced in Europe since World War II. This option may be more feasible today as the central bank has become the country’s main creditor. The Fed is trying to sell Treasury bonds acquired during the pandemic, but the failure of Silicon Valley Bank and other bank failures could further slow down demand for Treasuries. Canceling some of them outright may be the ultimate trick.
lastly, eliminate medical debt or tolerance student loan Usually from left-wing politicians, default is also an option or there is a possibility of force majeure.
Defaults are not uncommon in turbulent times in emerging markets.both Sri Lanka and Ghana It defaulted on its debts last year. While this option is not entirely unthinkable for developed countries, the resulting loss of confidence in the capitalist system would be significant.
4. Expand
Another popular debt relief protocol has emerged in recent decades, especially since the global financial crisis.
There are many precedents for extending repayment terms. West Germany benefited as part of it. 1953 London Debt Conference When creditor nations agree to halve outstanding amounts related to World War I reparations and post-World War II loans, and extend repayment terms by 30 years.
To ease the strain on public purses, governments can change debt service schedules over decades, turning 30-year bonds into longer-term instruments. Depending on the maturity of the loans, the public debt could become more or less permanent. In return, creditors may demand more generous returns than the near-zero interest rates imposed in recent years, but over the past few months there has been little debate about how to proceed, keeping real interest rates in record negative territory. guidelines were obtained.
To eliminate the risk of default or delay indefinitely, some governments We actually offer super long instruments. Although the United States does not issue any bonds, Duration of 30+ years over a century, France shows soft conditions on 50-year bonds. Austria, Belgium, Irelandand Germany We have selected the 100 year version, Italy may soon follow them.
Perpetual debt is a trendy way to extend your repayment obligations, especially among people who think: A sound government should refinance rather than pay off debt. However, ignoring excessive leverage to avoid difficult decisions can have disastrous consequences.
Japan has experienced “”.lost decades‘ shows poor stock market returns and a stagnant economy, even if it shows that increasing output is not the only policy available to the government. Maintaining a standard of living, even for the long term, may be sufficient.
Clearly, there is no shortage of ideas for addressing public debt burdens if governments wish to do so. Reduce the crowding out effect Or avoid recurrence in the US debt ceiling brink diplomacy.
However, the effect of excessive debt on economic output needs discussion.As a result of deeper institutional dysfunction,As historian Niall Ferguson suggested, or even a “public curse,” as James Madison put it, it misses the point. Debt has become a major source of funding for public and private efforts, and will remain so long as governments continue to stick to single-minded policies that promote growth.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of the CFA Institute or the author’s employer.
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