How I Learned to Stop Worrying and Love the Debt
During the holidays, I enjoyed a rainy afternoon watching Kubrick's Dr Strangelove. At some point, an analogy with present times struck me as evident: simply replacing 'Bomb' with 'Debt' and 'Nuclear War' with 'Bankruptcy' would make an actual remake of the plot!
The only difference with the 1964 movie would be that Peter Sellers would have to take on many more roles. Indeed, instead of playing just one Dr Strangelove, he would have to figure many similar characters that one can gather under the catchword 'policymakers'.
Has black comedy become a reality?
In a previous article, I suggested not to worry too much about inflation. Yet other clouds have been looming ahead for years: over-indebtedness and its corollary, insolvency. Both have been such a threat that well-advised experts even called for the return of inflation as the remedy to it – until inflation finally came back.
Policymakers failed to prevent the 2008 Great Recession (well, at least they managed to give it a nickname). While calling for austerity towards citizens, they responded to over-indebtedness with new strong incentives to over-indebtedness through unprecedented so-called quantitative easing policies. They did it again in 2020-2021, sparking an indecent appreciation of assets. And here we are now.
So, what about debts?
It goes without saying that public debts have increased at a pace never experienced in times of peace over the last decade. Indeed, political leaders, in coordination with central bankers, applied the few valuable lessons they learned after 2008-2009 to face the consequences of the global lockdown in 2020: support the economy at any cost. And the costs are high.
?General Government Gross Debt as % of GDP
Source: Eurostat
The burning question is, therefore: who will pay back the debts?
It is a legitimate worry stemming from honest citizens who think of national accounts as household ones. One must pay his debt in due time, after all.?
It's been worst in the good old times.
Dear, it was true when gentlemen lent and borrowed money in the good old times. Let us leap shortly into the past once again.
The UK public debt skyrocketed during American independence, the French revolution and the Empire wars: in 1815, debt reached 200% of GDP. In a context of zero inflation and high rates, it took one century to lower the ratio down to 30% of GDP[1]. It is all the more remarkable since the bulk of the debt was perpetual. The UK government paid 5% interest per year and only reimbursed a small part of the principal.
Likewise, it is worth noting that even France, after 1815 and 1870, had fully repaid its war debts and occupation allowances. How did they accomplish such a feat? Hint: thanks to sustained GDP growth (2.5% per year on average over the period). Those were the days.
This Time is Different. Is it?
In response to the economic crisis of 2008-2009, financial leaders chose to ignore the examples of the past. They argued for financial discipline (including compliance with the Maastricht rules), which is deleveraging through austerity rather than growth. This was undoubtedly the only thing to expect from advocates of financial orthodoxy.
The issue is that policymakers justified austerity programmes in some European countries by, among other things, the work of renowned economists like Kenneth and Rogoff. In their 2009 book, This Time is Different, these two economists lamented that people were not learning from history, especially from the recurring financial booms and busts.
Using the data they had collected, they argued the following year that "when?gross external debt reaches 60% of GDP, a country's annual growth declined by 2%, and for levels of external debt in excess of 90% of GDP growth was roughly cut in half."[2].
This has been free ammunition for austerity proponents. Unfortunately, their methodology was flawed, and the conclusion did not seem robust enough to many other economists, including Nobel laureate Paul Krugman. He wrote in 2013:
"The turn to austerity has been presented not as a choice but as a necessity. "Economic research", austerity advocates insisted, showed that terrible things happen once debt exceeds 90% of GDP. But "economic research" showed no such thing; a couple of economists made that assertion, while many others disagreed. Policymakers abandoned the unemployed and turned to austerity because they wanted to, not because they had to."[3].
The harm was done; we lost one decade of growth and social cohesion.
Dogmatics entrenched countries in austerity in the name of rigour and intellectual probity, relying on flawed economic work (just as Reagan did in the 1980s for other purposes, by the way). Instead, they could have relied on successful examples from the past, when countries managed to repay most of their debts through growth in a context of high real interest rates.
So, once again, who will pay the debt? Nobody knows, honestly, and nobody really knows whether anybody will.
Everything is on the table, from plain and painful repayment (the central scenario for policymakers) to erosion through inflation to worldwide debt restructuring, let alone significant social turmoil. Time will tell.
This Time is Different (Really)
Yet one thing is different, and it may be a game-changer: Real interest rates have fallen to schizophrenic levels and are here to stay.
Consequently, the interest burden on public debt in the major European countries has been halved or more in twenty years while debt levels to GDPs more than doubled in some countries.
For example, Italy needed the equivalent of 9% of GDP in 1997 only to pay public debt interests, France and Germany more than 3%, and the European Union on average almost 5%[4]. In 2020, the interest burden fell to 3.5% of GDP in Italy, 1.5% in France, 0.7% in Germany and 1.6% on average in the UE[5].?
Moreover, the central banks now own up to one-third of their domestic debt through successive asset purchase programmes. In addition to that, given that most governments managed to lengthen the duration of public debt, it seems that?we live in a world less stressed by over-indebtedness than what media rehearse.?
Conclusion: There is no point in escalating up to activating a doomsday machine, like in the original movie. Public debt is maybe less unsustainable than what hawks claim. But, unfortunately, most of them nest in Germany (it's another story).
Disclaimer: the opinions referenced above are solely those of the author. More precisely, they are among his currently preferred assumptions.
[1] Thomas Piketty, Capital in the Twenty-First Century, pp. 206-207 in the French version