WASHINGTON — The world's addiction to debt has reached a critical point, with governments globally struggling to manage soaring borrowing costs and investors growing increasingly wary of a potential debt crisis.
The average ratio of public debt to GDP in developed countries has surged to levels not seen since 1945, sparking concerns among economists and financial experts that a major crisis may be looming. The situation is further complicated by rising interest rates, which are making it more expensive for governments to service their debt.
"We're coming out of a zero-negative interest rate world where there's been nothing but encouraging taking on more debt," said Stephanie Kelton, a professor of economics and public policy at Stony Brook University. "But in a world where inflation is no longer low, that's when time is called upon the whole thing."
The issue is not limited to governments, as private sector debt has also grown significantly in recent years. Russell Napier, an adviser to investment institutions, noted that private borrowing and private debt are just as big a problem as government debt. "If we lived in a country where government debt to GDP was high, but private sector debt to GDP was low, then the consequences of this government debt addiction would actually be quite different," he said.
As the global economy continues to grapple with the aftermath of the COVID-19 pandemic and rising inflation, governments are facing increasing pressure to spend more on public services, infrastructure, and defense. However, this spending is likely to be funded by even more borrowing, adding to the already unsustainable levels of debt.
"The level of government borrowing is certainly one of the top questions I get asked amongst clients today," said Karen Ward, chief market strategist at JPMorgan Asset Management. "Government debt is supposed to be our safe haven asset, but it's supposed to be the boring bit. Now, it's becoming a major concern."
With interest rates expected to remain high, the burden of debt servicing costs will only continue to grow, making it even more challenging for governments to manage their finances. As Ed Yardeni, a renowned economist, warned, "In a world where it is not likely that inflation stays low, that is when time is called upon the whole thing. Supply and demand are running headlong into each other."
As the conversation continues, Ed Yardeni, president of Yardeni Research, weighs in on the concept of "bond vigilantes" and their role in maintaining fiscal discipline. "The bond market was the ultimate arbiter, right, of fiscal responsibility. The bond vigilantes, so to speak, step in and actually focus the mind of politicians," he explains.
Yardeni, who has been analyzing global macroeconomic and financial markets for over 45 years, recalls when he first wrote about the bond vigilantes in July 1983. During the 1970s, bond investors suffered significant losses as inflation soared and bond yields skyrocketed. Yardeni argued that if fiscal and monetary authorities failed to maintain discipline, the bond vigilantes would intervene, driving bond yields up to levels that could slow the economy and bring inflation under control.
However, despite the rise in debt, the bond vigilantes have been relatively quiet, with a few exceptions. One notable example is the UK, where the bond market rebelled against the Liz Truss government's fiscal policies in 2022. The resulting crisis led to a sharp increase in borrowing costs, which had a direct impact on household budgets. As Yardeni notes, "People's mortgage costs went through the roof. Bond markets matter in real life because it really hits the average household in the pocket pretty hard."
The UK's experience serves as a cautionary tale for governments around the world, highlighting the importance of maintaining fiscal credibility. While the UK is not currently facing a markets crisis, its position on debt sustainability is a concern. As Yardeni observes, "The UK is front and centre in many respects around the concerns of debt sustainability. So I don't think it's particularly a fiscal credibility problem here in the UK. There are questions over the long-term growth prospects here."
In contrast, the United States is facing significant challenges related to its deficit and debt profiles. With a deficit of around 6% of GDP, the US is running a substantial shortfall, which is alarming given the country's importance in the global economy. As Yardeni warns, "The big question is when the big boy here, the US, which has the biggest deficit, has completely unsustainable debt profiles, when do the bond vigilantes take against the US?"
The US federal government's debt interest payments have already reached $880 billion, four times the level of a decade ago, and exceeding military spending. This trajectory is unsustainable, and the consequences of not addressing the deficit could be severe. Yardeni argues that the US needs to make a bipartisan commitment to reduce the deficit to 3% of GDP, which would help to stabilize the debt and avoid a crisis.
Another expert, who remains unnamed, suggests that the way to frame the issue is to focus on the "financial surplus" rather than the deficit. By reframing the debate, it may be possible to reduce the temperature and find a more constructive solution. As this expert notes, "In the non-government part of the economy, call it the net contribution instead of the deficit. Call it the cumulative net contribution instead of the debt. The temperature would come down a lot if people understood that the thing we're fighting over is our financial surplus and our savings account."
The Trump administration's efforts to address the deficit have been met with skepticism, particularly with regards to the proposed Department of Government Efficiency. While Elon Musk has been tasked with reducing the deficit, it remains to be seen whether he can deliver on this promise. As the expert observes, "Maybe this Department of Government Efficiency, which Musk is supposed to head, will somehow find enormous savings, which will be enacted. I'm very, very skeptical that there's anything there which will be big enough to offset likely tax cuts."
The US is crucial to the global financial system, and its deficit and debt profiles have significant implications for the world economy. As one expert notes, "The US is crucial to the global financial system. The dollar is the world's currency of trade, of cross-border debt. People in other countries, big investors, central banks, they need to hold dollars. That means they need to buy US government debt. It's the benchmark safe asset for the whole world."
However, this also means that the US government has been able to be more free-spending than other countries, which could eventually lead to a crisis in the bond market. As the expert warns, "Now, that has enabled the US government to be more free spending than most others. Maybe the type of crisis that we've seen in the UK or in the eurozone a decade and a half ago could eventually come to the bond market. The economy that is at the centre of all of this. It could be really the most significant fiscal monetary problem in the world, and it could trigger destabilising events in financial markets."
The example of Japan, which has maintained high government debt levels for an extended period without significant consequences, offers a cautionary tale. As the expert notes, "On the flip side, we've also seen with a country like Japan that you can have very, very high government debt levels for a very long time and really nothing bad happens. The key to Japan's success, if you like, is that their very high debt levels have been accompanied by economic stagnation, where the central bank keeps interest rates very low, and also does quantitative easing, where it buys up all of the debt. So it doesn't really enter the market."
Ultimately, the US must address its deficit and debt profiles to avoid a crisis. As the expert concludes, "I did see a post from President Trump, two words all caps, balanced budget with tax cuts and a lot of spending on border and other things. I think it's more likely than not that we'll see large deficits continue." The question remains whether the US will take the necessary steps to reduce its deficit and stabilize its debt, or if the bond vigilantes will eventually take matters into their own hands.
As the global economy teeters on the edge of uncertainty, the issue of government debt has become a pressing concern. The United States, with its unique position as the world's reserve currency, has been able to maintain a high level of spending without facing the same level of scrutiny as other countries. However, this may not always be the case, and the possibility of a crisis in the bond market could have far-reaching consequences for the global economy.
The situation in Japan is often cited as an example of how a country can maintain high levels of government debt without experiencing significant economic instability. The key to Japan's success lies in its ability to keep interest rates low and engage in quantitative easing, which allows the central bank to buy up government debt and prevent it from entering the market. Additionally, the fact that the Japanese people are the primary creditors of the government means that they are willing to hold government debt at low yields, despite inflation.
However, not all countries are as fortunate as Japan. The Western world, in particular, is facing a significant problem with debt, and the situation in countries such as the United States and the United Kingdom is becoming increasingly precarious. The level of debt in these countries is staggering, and the ability of governments to continue borrowing at low interest rates is not guaranteed.
China, which has often been seen as a model for economic growth and development, is now facing its own set of challenges. The country's debt levels are rising rapidly, and the demographic shift towards an aging population is likely to put significant pressure on the government's finances. The situation in China is often compared to that of Japan 10, 20, or 30 years ago, and the implications are significant.
In Europe, the situation is also complex. The eurozone's public finances are stronger than those of the United Kingdom or the United States, but the region is not without its challenges. Italy, in particular, has a high level of debt, and the country's prime minister is under pressure to reduce spending and stabilize the economy. France, meanwhile, is struggling to rein in its spending, and the country's deficit and debt levels are a major concern.
Germany, which has long been seen as a model of fiscal responsibility, is now belatedly joining the global debt party. The country's new chancellor has announced plans to spend hundreds of billions of euros on defense and infrastructure, which is likely to have significant implications for the European economy. While some may view this as a positive development, others are more cautious, warning that the increase in borrowing could have unintended consequences.
Ultimately, the issue of government debt is a complex one, and there are no easy solutions. Either bond investors will have to accept lower returns, or governments will have to make significant cuts to their spending. However, with austerity not a viable option, it seems likely that the situation will continue to deteriorate, potentially leading to a debt spiral that could have far-reaching consequences for the global economy.
The so-called bond vigilantes, who have long been warning about the dangers of high government debt, may ultimately be proven right. However, their warnings may come too late, and the consequences of inaction could be severe. As one expert noted, the bond vigilantes may ultimately be "assassinated" by the very governments they are trying to warn. The situation is complex, and the outcome is far from certain, but one thing is clear: the issue of government debt is one that will not go away anytime soon.
As the conversation comes to a close, it's clear that the issue of government debt is a complex and multifaceted one. The speaker, an economist or financial expert, has walked us through the history of government debt, the role of bond vigilantes, and the potential consequences of unchecked borrowing. While some may argue that deficits can be useful in times of economic downturn, others warn of the dangers of inflation and the need for sustainable public finances.
Ultimately, the speaker suggests that inflating away the debt over a period of years may be the "least worst option," but acknowledges that this approach is not without its challenges. The fact remains that government debt has been a feature of economies for centuries, and it's unlikely that we'll see a world without it anytime soon.
As we consider the future of government debt, it's essential to remember that policymakers must balance the need for fiscal responsibility with the need for investment in critical areas like healthcare, education, and infrastructure. The delicate dance between borrowing and spending will continue to be a pressing issue, and one that requires careful consideration and nuanced decision-making.
In conclusion, the conversation highlights the importance of understanding the complexities of government debt and the need for sustainable public finances. As we move forward, it's crucial that we prioritize responsible fiscal management, while also acknowledging the role that government debt can play in supporting economic growth and development. By striking a balance between these competing priorities, we can work towards creating a more stable and prosperous economic future for all.
