Because economists are lousy forecasters, I don’t pretend to know when a fiscal crisis will occur or which nation will be the first debt domino.
But it will happen.
Indeed, I suspect it will happen the next time there’s an economic downturn (though I obviously can’t predict when that will happen, either).
Here’s a chart showing average government debt levels in the industrialized world.
It used to be that governments only incurred lots of debt because of war. They then paid down debts after wars ended.
But that pattern broke down about 50 years ago thanks to the creation of the welfare state.
Though not all governments are equally bad. I’ve noted that there are nations like Switzerland, Denmark, and Estonia that have low and/or falling debt levels.
Unfortunately, most of the world’s major nations are far less prudent. Here’s a chart looking at the G-7 countries. Only Germany and Canada have manageable debt levels (and even both of them have been rapidly deteriorating in recent years).
The above charts come from an article in the U.K.-based Economist.
Here are some excerpts, starting with a description of how governments get in trouble.
The magic of borrowing…comes with a temptation—one that David Hume and Alexander Hamilton worried about in the late 18th century. If a country is sufficiently creditworthy to cover its existing debts, it is in a position to borrow more. Having manageable debts means you can manage more debt. And so it is all too easy for debt to grow. If this goes on for too long, governments start to face pushback.
The bond markets which meet their need for debt start to charge them more. New borrowing gets harder—and so does rolling over old debts. If governments do not then tighten their belts, the country’s all-important creditworthiness erodes in a way which can easily spiral out of control. …today the biggest, richest countries have fallen into a dangerous pattern of borrowing ever more. Debts have reached vertiginous highs and bond markets are showing resistance.
The article then looks at some specific problem in western nations.
Governments have adopted mechanisms to constrain debts, such as America’s “pay as you go” rules in Congress or the EU’s Stability and Growth Pact. But politicians suspend, abuse or evade them almost as they please. …Bond markets are responding. …the longer the duration of a bond, the more investors must pay attention to the risks posed by lax budgeting. …
The prospect investors must worry about is not just—or even mainly—that of default. There is another weapon that can hurt them over long horizons: inflation. …Another problem in Europe is that taxes are high as a share of GDP, limiting the scope to raise them without doing excessive economic damage. …The IMF has estimated that debt interest, pensions, health, defence and climate change in Europe’s advanced economies will create additional annual spending “pressure” worth nearly 6% of GDP by 2050.
Since the above excerpt mentioned inflation, the Economist has a separate article predicting that’s how politicians will respond when a crisis unfolds.
Here are some of the relevant passages.
How long can governments live so far beyond their means? Rich-world public debt is already worth 110% of GDP… It is therefore increasingly likely that governments will instead resort to inflation and financial repression to reduce the real value of their high debts, as they did in the decades after the second world war.
…Price rises are unpopular—just ask the hapless Joe Biden—but they do not need political support to get going. Nobody voted for them in the 1970s or in 2022. When governments cannot get their act together, and run economic policies that are unsustainable, bouts of inflation just happen. …Yet that downward spiral is not inevitable. …Ronald Reagan and Margaret Thatcher…saw sound money as central to the pact between the state and the citizen. …Which path will the rich world take—ruinous or prudent? …If the world emerges with lower debts and conscious of the dangers of excessive borrowing, a renewal of sorts is possible. The alternative would be for the world’s most important economies to descend into chaos.
I have three comments on these two stories.
The first two deal with media bias, or perhaps media ignorance, while the final comment deals with substance.
- First, the writers at the Economist did not oppose the spending orgies during either the 2008 financial crisis or the 2020 pandemic, both of which played a big role in boosting red ink, so their sudden pearl-clutching about debt- while appropriate – is ironic.
- Second, while the authors acknowledge that higher taxes might not work, the second chart shared above doesn’t include a column on the burden of government spending, which probably will lead many readers to falsely think the solution is additional tax increases.
- Third, while the Economist does not seem to have the correct perspective, the issues raised in the two stories are deadly serious. Barring a sudden outbreak of Milei-ism, the western world is stumbling toward a very serious and very debilitating fiscal crisis.
But here’s the most important thing to understand. The problem is spending, not debt.
Excessive spending undermines prosperity whether it is financed by taxes, borrowing, or money-printing.
P.S. Notwithstanding the title of the magazine, the Economist has a weak record on some big economic issues (see here, here, and here).
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