Fear as the Magic Money Tree keeps on giving
Should we be relaxed about government debt? Spending and borrowing have risen astronomically in response to Covid-19, but governments seem less afraid of debt than in the past.
UK government debt now exceeds the total value of every product and service produced in Britain last year. Does it matter?
Facing the Covid-19 crisis, chancellor Rishi Sunak has had to reach for the Magic Money Tree, also known as government borrowing.
Policies such as the furlough system, and a declining tax-take have seen the budget deficit rise to £246bn in the last six months. For the previous fiscal year, the entire deficit stood at £60bn. Debt is now at 103% of GDP.
The UK is not alone in its debt-funded spending spree. Global government debt now equals total global GDP. Indeed, Britain is set to have the second lowest debt-to-GDP ratio of the G7 countries, after Germany.
The US congress has already passed a $2tn stimulus package and is haggling over another. If Joe Biden becomes President, he has promised to spend a further $7tn to boost the economy. Compared to this, the $800bn spent by Barack Obama after the 2008 recession seems positively tight-fisted.
For some, this spending is common sense. The IMF, which has traditionally been strict about government deficits, has argued for more public spending worldwide, not less.
After all, in spite of the rise in indebtedness, the cost of borrowing has gone down.
This is because government bonds, sold to fund debt, provide a safe haven for investors, particularly in countries like the UK or the USA, which can issue bonds in their own currency.
UK bonds, called gilts, have a yield of less than one per cent, but that is better than a loss for investors.
Some economists, advocates of what is called Modern Monetary Theory, go further, and argue that there is little need ever to worry about government debt.
Provided there is demand in the economy, they say, the government can create money, essentially from nothing. This is what happened with quantitative easing after the 2008 recession, where governments printed money to buy back their debt.
Others worry that rising debts mean rising interest rates, as happened in Greece in 2009. Beyond Europe, both Argentina and Lebanon are currently facing a debt crisis.
Part of the problem these countries face is because their debt is in a currency they do not control. Even if they did control the currency however, printing money raises fears of inflation.
This is where prices go up to reflect a perceived decline in the value of money. If everyone has more money, increasing demand, while supply does not increase, prices rise.
Inflation in developed countries has been low in recent years, however. So some see far more room for government debt before they start to worry about currency devaluation, or the other arguable downside of government spending, the crowding out of private investment.
As the theories diverge, the debt continues to mount in practice. Last year in a lecture, the former chief economist of the IMF argued that “Public debt may have no fiscal cost”, we are likely to find out how true that statement is in the coming years.
So should we be relaxed about government debt?
Yes we should, say some. Government spending helps to create demand and cuts could actually make the total debt problem worse, if the economy grows more slowly. Government debt is what created the stability that allowed the modern credit system to emerge in the seventeenth century. It is not like household debt; it is a necessary part of the modern world system, now more than ever.
No we should not, say others. Debt, by definition, has to be paid. It is only a way of postponing the pain. While in some cases, this is sensible, the can cannot be kicked down the road indefinitely. If debt grows too large, it stops being a problem for the future and becomes a problem for the present, as interest rates rise and inflation increases. We will soon be due a reckoning we cannot avoid.
- Should you be allowed to charge more in interest on a loan than the total value of that loan?
- Should a country be obliged to pay back the national debt accrued by a dictator after he or she is overthrown?
- In the Mount Hagen region of Papua New Guinea, people compete to give gifts that are worth more than the ones they have received. This extra on top of what is owed is called Moka. Imagine that a similar practice is instituted in your school and write a very short description of what might happen.
- Imagine you are an international bank who is owed money by an extremely poor nation. The finance minister has asked for a change in the rate of interest and a delay in paying. Write a letter to them explaining why you refuse to change the rates, and should receive your money now.
Some People Say...
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”Charles Dickens (1812-1870), English novelist
What do you think?
Q & A
- What do we know?
- It is widely agreed that increased spending was needed to mitigate Covid-19. Government debt has risen around the world. The UK budget deficit for the first six months of this year is over £200bn. This is an increase of about £170bn on the previous year. As a result, the total government debt has increased to £2.06 Trillion and the debt to GDP ratio topped 100% for the first time since 1960. Comparable increases in debt can be seen in all the major global economies, and the UK’s drastic increase still puts its ratio of debt to GDP lower than all of the G7 countries apart from Germany.
- What do we not know?
- One key area of debate is how much room there is for more debt in the global economy. For some, given the historically low interest rates, and the absence of inflation, now is an ideal time for the government to spend to drive demand. For others, the sheer scale of current debt, regardless of the conditions will become a problem. It doesn’t matter how gentle the sea is if your boat is too heavy. On the other hand, you may deeply regret throwing things overboard unnecessarily.
- Magic Money Tree
- This was a phrase used by then Prime Minister Theresa May in 2017 to describe the Labour Party’s more liberal attitude to public spending. May was likely alluding to a kind of Chinese good luck charm, a decorative tree associated with fortune.
- This used to be a word for a permitted absence, and refers to the scheme where the government subsidised the wages of those who could not work during the lockdown. The cost of the scheme is estimated at almost £40bn.
- Budget deficit
- The debt is the total amount of money that the government owes, but the deficit is the difference between how much the government spends and how much it earns.
- Fiscal year
- This is the accounting year of the government. Fiscal, in this and other contexts refers to tax and spending policies.
- Gross Domestic Product. This is the total monetary value of the goods and services produced in a country in a given year. The idea of GDP was first codified by Simon Kuznets in 1934.
- The group of seven countries are the world’s largest economies.
- The international Monetary Fund. Its main function has been to manage debt difficulties in many countries, often enforcing strict financial discipline in exchange for loans to governments.
- British government bonds have a gilded (gold) edge, and gilts is short for gilt-edged securities.
- Crowding out
- The theory that government spending crowds out investment operates on the basic principle that government debt increases interest rates, which makes it more costly for private businesses to borrow and invest. Ironically, it was the creation of government bond systems that first created the infrastructure for loans on the kind of terms now found acceptable to private business.