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Are we creating too much debt?

Governments around the world have cast off their usual fiscal caution during the pandemic slump. But is it really affordable?

Governments around the world have cast off their usual fiscal caution during the pandemic slump. But is it really affordable?

Charles Stanley

in Features


From New York to Berlin and from London to Tokyo there is agreement that government needs to borrow more to cushion the fall in economic activity. People have accepted that governments need to spend more to help businesses that are shuttered and people who might lose their jobs. They wearily shoulder the loss of substantial tax revenues as profits fall, individuals earn less – and people spend less on shuttered and impaired services.

This has been so far an affordable and sensible response, assuming as it does that this is a short sharp large hit to the economies which will soon be changed by recovery. Individuals have in the main kept their jobs, with many being paid their same wages and salaries for working from home. This majority have saved a lot as a result. They save on fares to and from work, they save on lunches, drinks and expensive coffees near the office. They save on tickets to entertainment and sporting events, foreign holidays and other services that were closed or greatly reduced during lockdown.

As a result, national figures for personal saving have shot up. In the UK where the savings rate is typically around 5% and under 10%, it hit 29% in the second quarter. The new large personal sector surplus requires the state sector and companies to borrow money to cover their corresponding deficits. Every coffee saved is money in the bank of the individual and money lost to the coffee shop. Every cancelled train journey is money lost to the state and its railway system and gained by the individual. There was some offset with the overseas sector. Every foreign holiday cancelled meant a smaller balance of payments deficit, so that was matched by some reduction in the corporate sector deficit where they picked up some of the spending lost to overseas business.

Enormous numbers

The figures involved in the new deficits are very large. Despite this, no advanced country has so far had any difficulty in raising the money to pay the bills. Central Banks have stepped in, promising to buy up large quantities of state borrowings at ultra-low rates. In effect governments and their Central banks are literally creating new money to spend, though they still go through the elaborate process of saying they are selling bonds or debts to the private sector only to buy them up or underwrite them in the Central Bank. When many of these countries can borrow for up to 10 years at zero interest, it is much like issuing no cost currency to pay the bills.

Some fear that markets will lose confidence in these practices and will one day conclude this is unsustainable. There is no obvious reason why this should be true for a sovereign country with its own currency. As long as the debt is issued in the country's own currency it can always be repaid anytime you like by printing more money. The past constraints on this process have come through inflation. If creating too much money simply generates more inflation, then the process has to stop. The braking mechanism is the currency exchange rate. Issue too much and the currency plunges. This hits the living standards of everyone in the country concerned as imports become dearer. So far, the opposite has happened. Inflation has fallen, thanks to the collapse in demand and the surplus of supply of many goods and services, especially things like oil which play an important role in the movements of inflation indices.

It is different if a country chooses to borrow a lot from overseas, or if it shares a currency with others as in the Eurozone. For any given Euro-area country it is as if they were borrowing in a foreign currency, as they cannot individually print Euros to repay their debts. They need the goodwill of the European Central Bank and a system to transfer money from surplus to deficit countries within the zone. If this current vogue to run larger deficits and to finance it through bonds gets into trouble it is more likely to be there, or in an emerging market country with high foreign currency borrowings.

Keep an eye on inflation

So, anyone worrying too much about the sustainability of massive deficits and large money creation programmes needs to keep a hawk's eye out for inflation. Only if we see that rearing up should we start to worry seriously. For the time being the US, UK and Eurozone can follow past Japanese practices of borrowing on a large scale, keeping rates near zero, and creating money to support the bond market. So far this has been a crisis of collapsed demand accompanied by weak inflation. In the Eurozone there will be legal constraints on excess and German resistance to too much money creation. In the US and UK there is likely to be more of an inflation limiter than in Japan.

Meanwhile, markets have been upset by the news that President Trump has Covid-19. It serves to underline the seriousness of the pandemic in the US and has made Mr Biden’s task easier. It highlights the health issue which Mr Trump wants to play down – and allows Mr Biden to cancel attack ads and the aggressive style of the debate which was arguably undercutting his message that he would be a more consensual kinder President. The election is still Mr Biden’s to lose.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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