Yet more debt...

Large parts of the global economy have shut down due to the coronavirus pandemic. In response, governments across the world have put forth large fiscal packages to help companies and workers survive through the temporary cash crunch caused by lost revenues and wages. Across the major economies, government debt is set to surge at their fastest pace since the Great Financial Crisis (GFC).  

Looking back at 2009, the government debt accumulated fighting the GFC was a source of widespread discussion, with certain commentators expressing concern. Similarly, what can we say about the further surge in global government debt we are now witnessing? 

Should governments increase borrowing?

There is often a feeling that accompanies large-scale borrowing, that all of this must surely come at a price? The answer isn’t a simple one. Whether or not more borrowing is harmful, depends on whether the borrowed funds are put to good use. If one borrowed dollar can be used to generate more than one dollar of growth, then the debt will pay for itself. A simplified analogy would be a college student taking on a loan to pay for his/her higher education. This education gives the student a better chance of securing a higher wage job, thus paying the debt off. 

Increasing government borrowing to fund cash support for workers and businesses temporarily impacted by lockdowns have a similar logic. When otherwise healthy businesses go bankrupt, or if workers lose their jobs, it’s not so easy for them to re-enter the economy when lockdown measures are eased. For example, a small/medium tech enterprise that’s forced into bankruptcy because of the lack of cash flow is forced to fire its researchers, who may not be as productive in another surviving firm with a different setup. Or workers who become unemployed, may lose their skills if they are unemployed for some time. While their individual effects are small, cumulatively, they can lead to semi-permanent ‘scars’ that slow the recovery. Economists call such phenomenon the ‘hysteresis effect’, and it’s one of the reasons why post-Crisis growth has been lacklustre. Here, increasing government borrowing to provide bridge cash financing for businesses and workers is likely money well spent, as it reduces the permanent scarring of the economy. 

What are the threats? 

This doesn’t mean that governments can borrow infinite amounts of money. There are natural limits to how much a government can borrow. The two big ones are interest rates and inflation. 

When governments borrow, they do so by issuing debt to investors. If investors become worried that a country’s debt pile is growing too fast, they require a higher interest rate to compensate them for the extra risk of lending it. This higher interest rate can crowd out private domestic spending through higher borrowing costs for companies, leaving the economy worse off. In the worst case scenario, foreign investors can dump the country’s debt en-masse, leading to excessive currency depreciation or financial instability. Previous emerging market debt crises are the result of this. 

Technically, a government that can issue in its own currency will never go bankrupt, as it can ‘print’ money to purchase its own debt. However, too much of this will eventually lead to hyperinflation, also leaving the country worse off. 

Thankfully, there aren’t signs that these limits are being breached. A large portion of developed government debt is trading at negative yields. At times of crisis, investors often prefer the safety of government bonds, instead of putting their money into riskier assets like stocks. The recent market sell-off in March saw large investor inflows into government bond funds. This makes it easier for governments to borrow more without being forced to pay much higher interest rates. At the same time, inflation remains lacklustre. Developed economies have the opposite problem – trying to raise inflation. 

Investment conclusion

The point of all of this is not to suggest there is nothing to worry about. It is more to try and provide the appropriate context for the fears around borrowing. In a world that looks very different from the past, with historically low interest and inflation rates, government have more room to borrow. Of course, this doesn’t apply to all governments (Italy for example, is an outlier to this). But commentators who claim that governments are borrowing too much because debt figures are way higher than previously, are ignoring the different economic landscape that we live in today. Such claims that we often see in headline news are over-simplistic, and shouldn’t be paid too much attention. For now, we should just be grateful that we have for the most part a cohort of policy makers in the major economies who aren’t bound by such flawed arguments.

Learn about Barclays Wealth Management, the affluent and high net worth service provider for Barclays UK.

or

Find out about our 'Ready-made investments' via our Smart Investor platform. A selection of five Barclays funds that each aims to increase the value of your investments over time, using a broad mix of asset classes from across the globe.

*This article is for information purposes only. It is not intended as a product offer or investment advice.