The Amount & Proportion of Public-Sector Debt is VERY Important

Does Debt Matter? Yes, it matters in a BIG way whether it is public-sector (government) debt or private-sector debt. Both the absolute amount & the debt-to-earnings ratio matter. And they matter a LOT!

And so, it is a good thing that there is so much discussion about the rising level of federal government debt in the USA.

Several unhelpful refrains are that public-sector debt is not big deal since, unlike private-sector debt, it can be endlessly rolled over or can be repaid with freshly-printed money.

And, never mind. We only owe it to ourselves & it is dutifully being held in our pension accounts! Anyway, interest rates are so very low that the cost of borrowing is negligible.

Alas, such silliness has been passed off as wisdom when uttered by Nobel Laureates & other mainstream economists. In turn, journalists & opinion makers have been co-conspirators in peddling this nonsense.

There are many reasons to worry about the continued expansion of fiscal deficits & government debt. Eventually, the amount & proportion of debt will reach a tipping point whereby an additional unit of debt cannot generate additional economic growth. At this point, stagnation will set in.

When debt (private or public) is used to support non-productive current spending, instead of promoting growth, it sets into motion a cycle of wealth destruction in the real economy. In other words, borrowing is used to repay interest or to cover operating expenses without adding to future revenue streams.

According to a Deutsche Bank study, the G-7 spent $18 to generate $1 of GDP over the past 5 years. For their part, G7 countries added almost $18 trillion of debt, including almost $5 trillion new liabilities on the balance sheets of their central banks, that generated only about $1 trillion of nominal GDP. Now the total debt of these countries is at a record high of $140 trillion so that their total consolidated debt-to-GDP ratio is 440%.

All the spending led to mushrooming deficits, debt and a troubling expansion of central bank balance sheets with little to show in terms of economic growth. In turn, the economic & financial systems have become increasingly fragile with small upward movements of interest rates likely to cause a massive adjustment.

Concerning the cost of debt, bond yields cannot remain artificially-low forever. Unfortunately, such low interest rates have encouraged an irresponsible accumulation of outstanding debt that will lead to enormous funding problems when unsustainably-low yields eventually increase.

Meanwhile, government borrowing has diverted funds away from private investing while the painfully-low interest rates have discouraged saving. This ongoing “financial repression” accompanied by attempts to impose new taxes or raise rates on existing ones to finance public spending comes at the expense of shrinking disposable household income & savings.

In sum, it ain’t a pretty picture.

A clearer way to look at the ongoing accumulation of debt is that has increased the accumulation of risk.

The most obvious risk is that the inevitable increase in servicing costs of public-sector debt will leave less for governments to spend out of existing tax revenues. And it is unlikely that the private sector can absorb an increased burden of taxes since higher interest rates are likely to trigger more foreclosures or bankruptcies, leading to lower tax revenues.

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About christopher

Content of "Natural Order" attempts to reflect the commitment of Universidad Francisco Marroquin to support the development of a society of free & responsible individuals. The principal commentator for this blog is Christopher Lingle.

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