The global debt obsession that refuses to wane
As borrowing levels soar to counter the pandemic,
Tim Wallace asks how much is simply too much
Wilkins Micawber – one of Charles Dickens’ most enduring comic creations – famously said that debt was a recipe for “misery”. But
David Copperfield aside, a little bit of debt is not necessarily a bad thing. It spreads the cost of purchases, and that can be sensible when making a big investment – buying a house, say, or an education.
Debt can be key to getting a business off the ground. Governments find debt handy to get through rough economic patches, or to make investments for the future. If children now benefit from a new school, for instance, then why not ask them to pay for it once they start work, and fund it in the meantime by borrowing? Or so the logic goes. Incurring extremely large debts can be worthwhile, for instance to win the Second World War.
Britain faces an extreme situation right now, if not quite as serious as global war. The national debt has just hit £2 trillion, equivalent to 100pc of GDP. It has not been this high as a share of national income since the Sixties. So this is an appropriate time to ask an uncomfortable question: how much debt is too much?
One answer is that borrowing is not a danger unless it becomes unaffordable. As with a household, this becomes a real problem when the interest bills rise too high, or when it becomes difficult to refinance. This has not been a problem for the UK, but wreaked havoc in Greece a few years ago. Even without becoming dangerously unsustainable, debt servicing costs can be a drag. Extra interest payments mean higher taxes, less money to spend on everything else, and slower economic growth. But this has not yet happened.
To judge from the debt markets, one would never know that borrowing had soared. The Debt Management Office has been put through its paces, issuing record levels of bonds and bills to bring in the cash. Despite this demand for funds, interest rates are at rock bottom. The Government can borrow for short maturities at negative rates, with investors paying for the privilege of lending to the Treasury.
This is part of a long downward trend in borrowing costs. Back in the Sixties around 10pc of government revenue went on interest payments.
By March 2020 the ratio was down below 4pc, a record low despite the legacy of debt from the financial crisis.
Attitudes to debt have changed over time, in financial markets as well as the political sphere. In the Nineties, Gordon Brown was keen to establish a reputation for “prudence”; he said the national debt should not rise above 40pc of GDP.
The ‘tipping point’
In the financial crisis, when he emphatically broke that rule, the World Bank said there appeared to be a “tipping point” as nations with public debts above 77pc of GDP typically suffered slower economic growth.
That in turn makes it harder to pay down the debts, making for lean years ahead. A famous, though controversial, paper by Carmen Reinhart and Ken Rogoff that year warned 90pc was a key tipping point. By 2012, Britain’s national debt was up to three quarters of GDP, and kept edging up. In 2015, then-chancellor George Osborne warned it was key to get this down as a precaution against any future crisis. “Unless we reduce it, we will not be able to support the economy and the British people in the way we would like to do when the shock comes, because we would not have the room for manoeuvre. Failing to address that is deeply irresponsible,” he told Parliament. “It is precisely because no one knows when the economy will be hit by the next shock that we should take precautions now.”
His policies to reduce the deficit might not have been universally popular at the time, but that “next shock” arrived with bells on this year.
Fitch Ratings estimates the debt could reach 120pc of GDP by the end of 2022. So should we worry? Interest rates suggest not, although there is no guarantee that markets have an unlimited demand for government debt. The Bank of England has contributed, hoovering up bonds with its quantitative easing programme, depressing rates in the markets.
But the fall in rates in recent years is global, and the Bank reminds people it reacts to market rates as much as it sets them.
The mood of markets also matters, as investors judge what borrowing is wise and what is reckless.
In countries such as Italy, where high-spending governments have ramped up dangerous deficits in good years, markets are often twitchy, only lending at fairly low rates when the authorities make sensible noises.
In Britain, which has tried harder to be sensible, markets can be more generous. Given the pandemic and the economic crunch, investors currently seem keen for the Government to keep borrowing to support the recovery.
But Rishi Sunak, the Chancellor, faces a Budget dilemma as the Autumn Statement approaches. A stronger rebound will put public finances on a sounder footing. By contrast, if the Government hiked taxes or slashed spending to get the deficit down, it could stunt growth and so inadvertently worsen its own financial position, with a smaller economy to service the debts. Ratings agencies downgraded the UK earlier in the year. But they are putting little pressure on governments to tighten up their finances in a pandemic, as a solid recovery is key to fiscal sustainability.
“Following the coronavirus crisis, we think policy support will remain for longer, or at least we would not expect a sharp tightening of fiscal policy as had happened in the aftermath of the financial crisis,” said Fitch Ratings. Its analysts note governments typically get more economic bang for their buck when spending in a recession. “This should ensure demand is not held back by tightening macro policy until 2025, although the possibility of post-crisis
fiscal tightening weighing on demand growth in the medium term is an important downside risk.”
Tax rises ‘risk scarring’
Kallum Pickering at Berenberg Bank says that by the final quarter of this year the economy will probably be 6pc to 7pc smaller than it was in February – matching the extent of the fall in the financial crisis. Nobody wanted to hike taxes or cut spending at the height of the slump, so nobody should consider it now, he says. Doing so would worry the markets more than a bigger deficit.
“Rather than viewing tax hikes as a prudent step, markets would welcome more borrowing now if it was put toward stimulating a robust recovery. There is a good case to be more aggressive now. The UK had a decent starting point, in terms of controlling
the debt before the pandemic, so if there is a one-off surge in borrowing with no inflationary pressures, who will care about the extra debt?” Pickering says. “If the Chancellor tightens up now with tax rises or spending cuts, it could lead to economic scarring, making the debt less sustainable and requiring austerity in future. Instead, he should invest more now to secure the recovery.”
Osborne, architect of much of that pre-pandemic deficit control, agrees. “Higher taxes will impair economic growth,” he said earlier this month.
The national debt might be terrifyingly huge, and nobody should be blasé about it.
But for now, the best way to get it under control is to stay calm and encourage more growth; not to launch an all-out battle against borrowing when the crisis is still raging.
‘Post-crisis fiscal tightening weighing on demand growth in the medium term is an important downside risk’
‘Markets would welcome more borrowing now if it was put toward stimulating a robust recovery’
Former chancellor Gordon Brown was forced to break his rule of national debt not rising above 40pc of GDP