Government debt: is there a way back?

The debt of developed countries is growing dynamically, especially since the outbreak of the 2007 crisis. Stimulating the economy, rescuing and recapitalizing banks, increased social spending (aid) and declining tax revenues as a result of the economic downturn have all plagued developed countries’ budgets.

Japan’s public debt is well above 200% of GDP, and the United States has exceeded 100%, unprecedented in the post-war period. But even in the western part of Europe, we do not find much less than 80% of government debt, not to mention 127% in Italy or 123% in Portugal. And it’s just a minor issue, the bigger one, that in most countries debt has been growing dynamically in recent years.

There are growing voices of concern as to whether there is a return from this ever-rising debt spiral? Holders of government bonds can sleep soundly, or will they face the Greek solution, where they could say goodbye to half their money forever and the other half will not be paid out on time?

Let’s see if there are examples of similarly high public debt in history and what the story ends.


The chart below shows the history of the US debt-to-GDP ratio, and below shows similar figures for Britain. But I could mention Canada, Australia, and countless countries where government debt was well above 100% and managed to reduce it dynamically over a few decades. In just 20 years, the United States cleared two-thirds of its debt-to-GDP ratio between 1946 and 1966, and Britain’s performance is even more impressive.

So there is no cause for concern, there will still be a solution, the current state is not the end of the world, it was much worse not so long ago.

We might think at first glance.

However, it would be worthwhile to look a little deeper into the historical background. As you can see, the debt of developed countries has so far only jumped during a single war, whereas the present situation is completely different.

(Just a small detour: the solution suggested by Keynes in the 1929 global crisis was about a completely different state. At that time, US government debt was below 20% and even annual central budgets were in surplus. This is radically different from the outbreak of the 2007 crisis the world, so it was not a wise idea to go for Keynesian solutions right away, and Keynes says that if the economy stops, it may even make nonsense public spending, but the state has to start by spending money on market players. )

But before we look at how most states have been able to reduce their public debt after the World War, let’s summarize what the debt reduction options are.


– Planning a budget with a surplus, that is, the state takes in more tax than it pays for its costs and spends the extra money on debt reduction. In such cases, the taxpayer bears the cost of reducing the public debt. This was the case in the US, for example, during the Clinton era around the 2000s.

– Planning lower budget deficits than expected GDP growth. In this case, although debt continues to increase, government debt-to-GDP ratio is declining due to higher GDP growth. This is better for taxpayers at the moment, but ultimately, the debt burden on the economy continues to grow.

– Inflation of debt. In such cases, the debtors who are debt holders, the policyholders, suffer the full loss.

– Currency reform, replacement of existing money with a new one. (Pengo-forint)

– Refusal of repayment, bankruptcy.

Based on the American example, what was different then and how did the post-war reduction succeed?

The first important point was that, until President Reagan came to power, by 1980, all US governments were committed to a nil or near-nil budget. Even after the First World War, the declared aim was to eliminate debt as soon as possible. (In the First World War, the US entered with a debt of 2.7% and faced a record 33% debt at the end.)

It was no different after World War II. Although nominal debt has been increasing year by year, adjusting it for inflation, we can see that it hasn’t really changed. Add to this the dynamically rising GDP figures, we can see that disciplined fiscal policy has achieved its goal.

This has changed radically in Reagan times:

From the eighties, a balanced budget was no longer an issue, and it was the result. The Reagan tax cuts proved tragic for the budget.


How else was the situation then?

– American government bonds had an average residual maturity of 9.4 years in 1947, with an interest rate of 2.9%, while inflation, for example, was 68.8% between 1942 and 1952.

In other words, policyholders lost half of their wealth in 10 years due to inflation but could not do anything about it in the long term. (Their loss was the state’s profit on debt.)

However, currently 45% of US government bonds mature within one year and 55% within two years. Therefore, today, this trick is no longer playable, because lenders easily think at maturity that I would rather not buy government bonds again, that is, falling demand will result in rising prices at lightning speed. (This is currently not the case due to the Fed’s $ 85 billion monthly bond purchase, but if it is over, the market will adjust quickly.)

– Until 1960, virtually all US debt was in US hands, currently 48.2% is in foreign hands. On the one hand, this is welcome, since half of the potential inflationary losses are borne by foreign policyholders, but they are the ones who quickly exit the market if their ongoing losses occur.

– After the Second World War, the only world currency was the dollar, and no one on the world market could easily bypass their money. Today you can choose between the Euro, the British Pound, the Australian Dollar or the Yuan or Ruble. This will also make it more difficult to inflate US debt.

– The US regulations of that time maximized the interest rates that banks could afford, on the one hand, to keep yields below inflation, and, on the other, to artificially attract their own government bonds. This is impracticable in today’s global money market, and even so-called Euro Dollars have already appeared, covering non-US dollar investments that have been taken out of the country due to higher yields, thus circumventing restrictions.

– The American society of that time was demographically healthy, and the baby boomers were born, just the ones who are retiring now, burdening welfare systems and reducing tax payments.

This is the American situation, the European one is worse. Many studies have been carried out that, with the current low growth and high unemployment, it is an economic impossibility to inflate public debt. Because most countries have low government bond maturities and need to be renewed month by month, not a single attempt at rescheduling would do nothing more than a rapid rise in interest rates.

And it is easy to see how much more interest there is on the size of government debt, how much interest it has to pay each year. Just like your home loan, whether it’s 6% or 12% annual interest rate, Japan is much easier to pay around 0% interest on your 220% debt than Hungary 5% average interest on your 80% debt .

And if we want to play with inflation, but only end interest rates, then governments are not doing better, but much worse.

And if we want to play with inflation, but only end interest rates, then governments are not doing better, but much worse.

In addition, there are also the fundamental causes in Europe, the excessive social benefits and other welfare expenditures that have caused public debt. Together with the aging society and the demographic crisis, these are the real triggers. These should be resolved first so that debt does not recur.

Well, the post was a little long. So, I’m not saying it’s the end of the world, it’s just that the current situation is different in every way than the post-World War II era, and it would be a big mistake to start with how and why we got rid of sovereign debt. In the current situation, almost no one knows what the solution would be; in a recessionary economy, austerity does not appear to be feasible, but public debt is becoming increasingly unmanageable.

Unorthodox monetary solutions, the purchase of bonds by central banks, and artificially low interest rates all add up to the problem, but pretty much nobody knows what’s going to happen. If interest rates are kept low for a long time, there will be another credit crunch and a real estate bubble due to too cheap loans, if they are raised, the economy will be squeezed into interest rates on its debt.

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