Debt Dynamics

While history may suggest that the current levels of public debt is not necessarily a new problem, the current scale of public and private debt is very high by almost any comparison. Therefore, we possibly need to highlight the distinction between public and private debt. Public debt is caused when government spending exceeds its tax revenues, which creates a deficit that accumulates year-on-year into the public or national debt. In contrast, private debt might be described in terms of both household debt, i.e. credit cards and mortgages, plus corporate and business debts.

As a broad generalisation, many developed economies now have far more private debt than public debt. However, while these two types of debt are distinct in ownership, they both invariably reflect the underlying state of the economy.

Note: When an economy goes into recession, government tax revenues can fall and the deficit rise. In response, governments may be forced to cut spending in the form of various austerity programs that ultimately affects the income of many people, especially the poorest in society. Recessions also affect business and investment confidence, which can cause a risk-adverse private banking sector to stop lending into other sectors of the economy that often most need a cash injection to address the downturn in profits and rising prices. As a consequence, many businesses are forced to downsize their workforce to cut costs, which not only means a loss of wages in the economy, but a further lowering of tax revenues and increased government spending in the form of benefits and social welfare, i.e. the deficit grows.

Even on the basis of the brief outline above, we might realise a level of feedback dependency within an economy, the dynamics of which makes it difficult to predict. As a consequence, economists have many differing opinions of what might work, but not necessarily a clear strategy as to what will actually work. So while there may be some consensus that debt should be reduced and the economy stimulated towards growth, the approach taken to achieve one of these goals may often appears contradictory to achieving the other. As such, it might be worth reviewing some of the general approaches used to tackle the debt, while also stimulating economic growth.

  • Currency Injection: As outlined in the previous discussion of currency dynamics, governments often issue bonds, or IOUs, to return currency to the treasury, which can then be spent by the government in an attempt to stimulate the economy in the hope that it will eventually generate an increase in tax revenues to offset the initial increase in public debt and the interest paid on this bond debt. However, history suggests that this approach may only have limited success in the context of the 2008 financial crash. Likewise, the idea of quantitative easing (QE) has also been attempted to stimulate the economy by buying back previously issued bonds with new currency created by the central bank, which it is hoped will flow out into the wider economy via the original investors of bonds and the private banks. Unfortunately, the previous model suggested that this approach can also see most of the currency injection end up in the hands of private banks, which in a time of a financial crisis only uses this currency to first recover their own balance sheets, while restricting loans to only those who can offer some form of equity guarantee against default. If so, the net result of this currency injection may only help to re-inflate the property market rather than to stimulate growth in the wider economy.

  • Interest Rates: Lowering interest rates is another way governments have traditionally attempted to stimulate the economy and in-turn increase tax revenue in an attempt to reduce public debt. In principle, low interest rates make it easier for both individuals and businesses to borrow currency, which we might initially assume will be spent on goods and services, which boosts the economy and helps to create employment and, in so doing, increase tax revenues and reduce welfare benefits. Of course, even at near zero rates of interest, loans may be difficult to get if the private banks remain risk adverse towards certain sectors of the wider economy. Equally, many individuals and businesses are often very reluctant to take on more debt in a time of economic uncertainty, let alone a full-blow recession. As such, this approach has not proved to be too successful in recent years.

  • Taxation and Austerity: In the face of an increasing deficit between government spending and tax revenues, the government is often face with the choice of increasing taxation to cover the deficit or cutting spending through various austerity programs. Neither approach is popular with the voting public, which leaves the government having to make a political compromise, which may fall short of an economic solution. In a time of recession, the poorest sections of society are often the worst affected, especially if resulting in increased unemployment. As such, the government is often forced into increased welfare benefits and tax relief for an increasingly large section of society, i.e. the unemployed, which only causes the deficit to rise. On the other hand, while increasing taxation of the rich and powerful may appear to be another way to balance the books, it is invariably resisted by influential pressure groups that have their own political and/or financial agenda. While, austerity might appear to result in an immediate cut in government spending, it can also result in unwelcomed downward pressures on the economy as a whole, while taxing the rich often risks the threat of businesses being moved offshore, which could increase the debt-to-GDP ratio in the longer term. In the end, most governments invariably seek some form of political compromise between immediate austerity and longer term taxation reforms, which while possibly helping to reduce the deficit, it would not guarantee to eliminate it. In this respect, debt is often considered to be a long-term economic problem that has to be balanced against the short-term political imperative of re-election.

  • Debt Default:  History suggests that allowing a level of both public and private debt default has been a relatively successful strategy in order to reduced the overall debt in an economy, such that it might be restructured towards growth. However, while history might support this idea, especially when considering the overall stability of society, it is invariably resisted by powerful banking interests that would have to write-down these loans as losses on their balance sheet. However, we possibly need to consider the implication of debt default in two ways, i.e. government defaults and debt jubilee for individuals.

    • As an extreme form of government default, it might simply refuse to pay its debts to its creditors. However, this approach would invariably lead to the government being black-listed from any further international credit plus risk a threat of severe economic sanctions and seizure of all its overseas assets by way of compensation. As such, this is probably not a sensible approach to achieve debt relief. However, while most bank creditors may well resist any idea of debt default, it is possible that some form of bilaterally agreed debt write-down might be a  compromise solution in order to maintain overall social and economic stability. For example, the economic problems in Greece are well-known in terms of its participation in the Euro currency, which has resulted in a level of debt repayments requiring a severe austerity program to be imposed on the general Greek population by the European Central Bank, apparently due to the insistence of the German government. However, some have argued that the German economy has also been a beneficiary of this situation because its export prices have been kept artificially low as a result of the weaken exchange rate of the Euro. If so, this gain could be used to compensate German creditors and allow a partial write down of some of the Greek debt burden.

    • The idea of a debt jubilee has a long history, where individuals who had been reduced to slavery or debt bondage were freed, typically on some significant event or cyclic period, in order to stabilise society and its economy. In a modern context, we might better describe this form of debt relief as a tax rebate that is given to the entire adult population, but with the caveat that those in debt must use the tax rebate to pay down their debts, while the rest might use the windfall to stimulate all sections of the economy.

While the ideas outlined under ‘debt default’ might seem to be possible options to reduce overall debt, especially given the apparent failure of all the other approaches outlined, it would seem that the powerful interests of international bank creditors have generally overruled such ideas being seriously considered by governments. As a result, debt reduction essentially remains an unsolved problems while banks continue to prioritise the payment of interest on the high-level of debt in the global economy. Against this backdrop, economists appear to only argue, back and forth, about the interpretative results of essentially academic models, which in all probability are based on flawed data and wrong assumptions. As such, the debt problem is not really being addressed, but rather maintain to underwrite the profits of powerful financial institutions, irrespective of the wider consequences to society as a whole. In this context, the note below possibly reflects the ethos, i.e. lack of morality, within the global economy, especially towards poor developing nation-states, although it is probably safe to assume that this indifference extends to the poor majority within any nation-state, irrespective of definition of developed or developing.

Note: Many developing countries have very large debts, and the amount they owe has continued to grow year-on-year. As a consequence, paying off debt has become a serious problem for these countries and an even greater hardship for their people. By way of an example, some regions of Africa are paying more than 5 times the amount in debt repayment than they spend on health care and education combined. Of course, in some quarters this foreign debt might simply be described as an ‘exciting new investment opportunity’.

Irrespective of whether we discuss debt in terms of the public or private debt, it has become the life-blood of a myriad of financial institutions that appear to view the world in terms of their own self-interests. However, at this point, the scale of debt in question has not really been quantified, such that it might be useful to introduced some figures that may help reflect the state of the US economy, i.e. supposedly the richest nation-state on planet Earth. In this context, GDP is often seen as the most widely used measure of the health of an economy, where the US GDP is estimated to be $18,000 billion. However, even ignoring the debate of GDP versus GNP, many economists believe that GDP is a flawed measure because it does not reflect the economic state of society as a whole. For example, it is possible for GDP to grow, while the average income falls, such that poverty can be increasing, which might only be realised when reviewing the growing wealth gap between the top and bottom sections of society, as shown above. In addition, it might also be argued that GDP does not measure environmental deterioration, which might question the sustainability of GDP growth into the future. Other measures of a healthy society might also include life expectancy across all sections of society along with infant mortality and malnutrition rates, none of which are inferred by GDP. So despite these concerns, we might compare US tax revenues, e.g. $4,700 billion, and expenditure, e.g. $5,252 billion, as a percentage of GDP, e.g. ~26% and ~29% respectively. From these figures we might realise that US government is running a deficit of $552 billion, i.e. ~3% per year, which continues to grow the US public debt towards $20,000 billion or 111% of GDP, while the US private debt has increased  towards $35,000 billion or 195% of GDP. However, it might be said that comparing the public debt to tax revenue would provide a better indicator of the size of this debt, i.e. 425% of tax revenue. Of course, we might immediately see why most governments do not want to use such a comparison, especially if GDP does not accurately measure even domestic growth – see note below.

Note: Some 80% of bank loans in the English-speaking world are associated with property mortgages, where loans are drawn against stocks and bonds already issued. This situation is reflected in the level of debt tracking GDP growth over the last 60 years or so. If so, this might imply that the real economy of production has flat-lined over all this time, despite the huge advantages technology developments should have made to overall productivity.