Wednesday, 2 November 2011

A thought about debt...

This morning while trundling along going nowhere on the treadmill my mind wandered onto this thorny problem of "the debt". After all it's the subject of great discussion by our masters across Europe as we come to terms with the impact that years of artificially low interest rates and profligate governments have had on the national balance sheets.

One argument out there is what we might term "debt denial" - or rather the belief that by taxing rich people and rich companies a little more all the problems will go away. The more sophisticated voices out there put on their best frowny clever-person faces and tell us that, of course, government debt is different:

What I have in mind is this idea that you can keep running deficits which, if they grow no faster than GDP, can create a debt that is stable at a desired share of GDP.

Got that folks? Spotted the problem haven't you! It's the Mr Micawber principle:

"Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." 

The problem is the fundamental rule of debt. At some point you have to pay it back - with interest. Government debt is objectively no different at all from the debt that you and I may have as private persons - we borrow money and, at an agreed point, pay that money back. To pretend otherwise is to believe a nonsense.

Right now we are playing two games to avoid having to face up to repayment - firstly we're inflating the economy with freshly printed moolah. If the value of the pound in your pocket gets smaller through this inflation it means the debt on the government's balance sheets (including all that private debt they nationalised when they "bailed out" the banks) also gets smaller. Less to repay!

Secondly we're urging economic growth - using exactly the same methods (low interest rates, government funny money, infrastructure projects) that created the problem in the first place. The bet is (and it's a bet with your and my money) that the extra money in the economy will stimulate economic growth which will help solve the problem by producing more tax income and thereby reduce the need to borrow.

In the meantime government continues that borrowing (and the Bank of England its printing of money to lend to the government) so as to avoid the discussion about that first principle of debt - you have to pay it back.

As Mr Micawber knew and clever economists, bankers and politicians forget, we should live within our means.


1 comment:

Frances Coppola said...

Nice, but sadly incorrect. You ignore the fact that bond markets LIKE government debt. In fact they need it - lots of it. So no, government debt doesn't have to be paid back. It has to be rolled over, yes - and if the bond markets think the economy is looking dodgy or the government is spending too much, that refinancing can become a bit more difficult and interest rates rise. But paying it back - no, no-one does that.

Actually if a well-regarded government looks like it might start paying back debt - for example if it has a primary surplus - bond markets start to worry about loss of liquidity. Which is why the last time the Australian government had a primary surplus, it was lobbied by representatives of the finance industry to issue more debt even though it didn't need it. Oh, and those finance representatives didn't want the government to spend that money either. In fact they wanted the government to cut spending further even though it had a primary surplus and excess debt. Government spending raises the risk, you see....

So bond markets want governments to cut spending, yes, but not so they can reduce their debt. What they would really like is a government that issues lots of debt on which it pays interest, but keeps that money in reserve rather than spending it into the economy. That way the risk is zero.

Illogical? Not really. If you start to regard government debt as a giant savings scheme rather than a way of funding public spending, it all makes much more sense. Think about it.