The paradox of debt
Modern economies are drowning in rising levels of debt – but does it matter? Stuart Watkins reports
Debt as a percentage of GDP has grown rapidly over the past half century in the US and in other major developed countries. This is true of both government and private-sector debts. In the US, total debt grew from about 150% of GDP in 1970 to around 300% today. The six other big economies – the UK, China, France, Germany, India and Japan – have been on similar trajectories. But this is a feature of how modern economies work, not a bug, says Richard Vague in The
Paradox of Debt (Forum, £20), published last year. The ratio of debt to income in economies almost always rises, he notes, and that’s mostly for the good. Debt tends to rise because new money is always required for economic growth and the technological advances that raise prosperity, and money, in his account, “is itself created by debt” – he defines money as the US Federal Reserve’s M2 measure, which is mostly the stuff in current accounts, created by the lending of private banks. So as economies grow, and demand for money rises, so too must the demand for, and supply of, debt.
The paradox of his book’s title comes in when you appreciate that you can have too much of a good thing. As debt grows, the burden of servicing it depresses real incomes and raises inequality (because debt fuels higher asset prices, which mostly benefits those rich enough to own them). This slows economic growth and “can bring economic calamity” when the bubble bursts.
What then is to be done? Vague has a minimum and a maximum programme. Minimally, policymakers need to understand the dynamics of debt better, and realise that there is next to no chance of growing out of it with productivity improvements, or simply paying it off or inflating it away– at least not without applying cures that are worse than the disease, in that they choke off growth. Policymakers need instead to recognise that some debt must simply be written off or restructured, and to intervene through tax and other changes when debt, especially private-sector debt, is accumulating too rapidly. His maximum programme would be to switch to a monetary regime that creates money without also creating debt – in effect, the central bank would simply print more of it and credit it to the government’s account, while being disciplined and judicious enough not to do too much of this and hence create inflation.
Some surprising facts
Vague’s outlook seems to make sense of some things that might otherwise be surprising. In 2020, at the start of the Covid panic, the US government spent $3trn to prop up the economy, thereby increasing its debt and reducing its wealth by “almost the entirety of that frighteningly large amount”. You might expect that to have had “broad, adverse financial consequences”. Yet household wealth in that same year increased, not just by the $3trn injected into the economy, but by a “whopping” $14.5trn, the largest recorded increase in household wealth in history. The wealth of the country as a whole – that is, with households, businesses and the government added together – increased by $11trn.
That seems to fly in the face of those who worry about the likely consequences of high levels of government debt – that it will constrain spending, crowd out lending and investment, and lead to higher interest rates and inflation. In reality, debt levels have kept rising, yet in the years since the early 1980s interest rates have generally plummeted, investment has remained high and household net worth has risen.
In short, Vague agrees with former US vice-president Dick Cheney when he claimed, to much derision, that “deficits don’t matter”. To make this argument, Vague, who has worked in banking and as a venture capitalist, “sets aside” standard economics and instead scrutinises the balance sheets of the economy as a whole, as an accountant would an individual enterprise. His book traces how a nation’s money flows through households, the financial sector, businesses, government and out to the rest of the world – and his audit leads to some surprising conclusions. He denies, for example, that there is any necessary connection between growth in the supply of (debt-based) money and inflation, or that high levels of debt to GDP necessarily signal danger.
The rapid build-up of private, especially household, debt, is dangerous, however, and heralds the start of a crisis – it would have been simplicity itself, says Vague, to see the 2008 financial crisis coming, and applying his insights should enable us more accurately to “forecast economic trends, predict financial crises, shape policy decisions, and understand how national wealth grows and thus how to address inequality”.
How to do that? Vague sketches some ideas at the end of his book. Policymakers should keep an eye on how fast debt, particularly private-sector debt, is being run up, and intervene to curb the most dangerous excesses by organising debt write-offs in such a way that the costs fall on the broadest shoulders and in areas least likely to crimp growth. He advocates in particular debt jubilees in areas such as student loans – something Joe Biden has been pursuing. Vague also proposes cutting trade deficits, but by going for growth in areas where the US enjoys a comparative advantage, rather than by trying to revive or restore manufacturing. Whether all this, not to mention his more wildly ambitious maximum programme, appeals, will depend on your faith in the powers of all-seeing, passionless technocrats with a politically disinterested command of the data over the emergent order created by free markets. Still, Vague’s book is admirably well written and pacy given that it is basically a walk through the accounts, and he makes his arguments clear for the uninitiated. It is a thought-provoking challenge to economic orthodoxy.