Government Debt – Kicking the Can Down an Endless Road
According to the old saying, “if you owe the bank $100 that’s your problem, but if you owe them $100 million it’s their problem.” Whose problem is it, though, if you owe $13 trillion? The US federal debt is fast approaching that figure, yet nobody seems sure if it’s a problem, or, if it is, whose problem it is. Stranger still, few people seem very worried about it.
The credit ratings agencies and the money markets don’t seem to be. They base a country’s credit worthiness on a multitude of complex economic factors like GDP, inflation, import/export surplus or deficit, unemployment, social policy, competitiveness, social and political stability, industrial productivity, debt repayment history, current national debt, etc. as well as the projected future performance in all those areas. Taking all factors into account, the markets are more than happy to lend the US government money at historically low interest rates.
Borrowing by Any Other Name
Some argue that the reason the markets don’t worry much about US government debt is because they don’t regard it as “real” borrowing. Sure, the loans have to be repaid, but only in theory. Governments repay bond debts by issuing new ones, i.e. by borrowing again – kicking the can down the seemingly endless road. Governments can repeatedly kick that can as long as the markets are willing to loan them money at a reasonable rate and, in the US case, the markets have always been willing to do so.
The markets don’t, however, feel the same about all countries’ debt. After the 2008/09 financial crisis, many countries’ economies were in deep trouble and they were effectively excluded from the international bond markets because lenders worried that they would default. In theory, those countries could still have borrowed, but they would have had to pay enormous interest rates – at one point Greece would have had to pay the markets 40% annual interest on new borrowings. They would have defaulted if they had not been rescued by the EU, the ECB, and the IMF (the group that became known as “the troika”). One condition the troika imposed on Greece was that it run a fiscal surplus for a number of years. That meant not only that the country had to fund all government services from current (and falling) tax receipts, but also pay back a portion of existing loans. That resulted in massive cutbacks in state services precipitating austerity conditions for most people.
What came to be called the “Euro Crisis” is a salutary lesson in government borrowing. The crisis variously affected Portugal, Italy, Ireland, Greece and Spain. Though they were rescued by the troika, the countries’ fiscal hands were tied. Had they not been part of the Eurozone, they could have devalued their own currencies or printed money. Experts are divided on whether these solutions would have caused less hardship for the citizens. Most agree that the troika forced the countries to put their economies in order and that it paid off in the long term. It also proved that the proverbial can can’t always be kicked down the road.
When Is Government Debt OK
Most governments, including the US government, frequently run current account deficit, which they fund by borrowing money. Economic novices often ask: why don’t governments simply cover the deficit by increasing taxation? There are two reasons. First, raising taxes is politically unpopular. Second, it has unpredictable consequences: It reduces people’s disposable income, so they spend less. That hits company profits and causes layoffs. Income and other tax receipts fall, while unemployment and related social support costs increase. So, paradoxically, raising taxes can lead to reduced tax receipts and a bigger budget shortfall. It’s less problematic to just borrow money to cover the deficit. If there’s even modest inflation over the loan period, the government may effectively pay little or no interest on the borrowed money. Solving problems with cheap money, however, means governments have less incentive to address structural inefficiencies in the economy.
How Much Government Debt is Acceptable?
Many, including the IMF, believe that a developed country’s total government debt becomes a potential problem if it heads toward 90% of GDP. For developing nations that ceiling is 30%.
As of December 2017, the $13 trillion US government debt held by the money markets represented approximately 77% of GDP. The Congressional Budget Office estimates that the figure will increase to 86% by 2026. Is the US headed for trouble? Perhaps, but it’s instructive to note that immediately after WW2 US government debt rose to 122% of GDP and yet fell to very manageable proportions within less than a decade.
Follow the Money
For many people the best way to quantify a country’s risk of defaulting, or not, is to study the bond markets and the ratings agencies. Cumulatively, they carry out most research on all the risk factors and the markets have most skin in the game. The markets have always been willing to lend money at low interest rates to the US and most other western governments. In the US today, despite the lack of bipartisan agreement on budgetary and other matters, the markets are confident that, as the world’s largest economy, the US is a safe bet. They believe that because, even in difficult times, the government has many options. It can devalue, it can print money, or it can raise more taxes from its hundreds of millions of individual and corporate taxpayers.
In their book, “This Time is Different,” economists Reinhart and Rogoff write “it stands to reason that at some point government spending on productive endeavors like investment on physical capital, R&D and education and training can be crowded out over time by increasing net interest expense. Ultimately, it could be argued that this can act to dampen overall economic growth.”
That’s hardly strong criticism of excessive government borrowing. But it sums up the current state of expert thinking about government debt levels, namely, that nobody is really sure what to think.
And that, to me, is scary.
P.S. Thank you for the very kind messages received about NightFood and the recent surge in the share price. When we first mentioned $NGTF it was trading at around 0.09 on small volume. The share price has increased by 700% to a current 0.60 in just 2 months on very significant volumes. Here is the latest Press Release.