Bullion Bulletin: Debt relief

The Institute of International Finance (IIF), a Washington D.C. bankers’ lobbying group, reports that global debt last year fell by about $4 trillion. It’s now below the $300 trillion it reached in 2021. Before we cheer we should note that debt in emerging markets rose to a new record, $98 trillion; India, Mexico, Russia, Singapore, and Vietnam registered the largest individual rises. Sri Lanka, Ghana and Zambia are already in default – they can’t pay back their debts. Today this is a problem for those countries; tomorrow it could be a problem for the world, as the debt dominos start to tumble and pushes us all into recession or worse. The question is – who gets to eat how much loss?

The cost of servicing massive debts is one reason why governments only raise interest rates under great pressure. It’s why the US Federal Reserve’s Open Market Committee (which sets America’s interest rates) has never once in the recent inflationary period set interest rates higher than the rate of inflation. The Consumer Price Index (CPI, the US government’s preferred benchmark for inflation) was 6.4% in January, but the Fed’s interest rate is 4.50%-4.75%. To be certain of killing inflation the interest rate should be higher than the inflation rate. The FOMC wants to kill inflation but without putting interest rates so high the risk becomes a recession – and soaring interest rate payments on US debt.

Each time they push up rates all those with non-fixed credit costs suffer pain, but governments’ interest bills go up too. Higher interest rates make the cost-of-living worse, for governments too.

The published national debt of the US is now fast approaching $32 trillion; but by some measures (which take account of unfunded Social Security and Medicare pledges) it’s closer to a staggering $150 trillion. The UK’s debt is a minnow compared to this whale; almost £2.4 trillion.

Are these countries able to repay these debts? We need to consider the debt-to-GDP ratio: the Gross Domestic Product or GDP tells us the value of all the goods and services a country produces. The US debt-to-GDP ratio is around 120%; the UK’s is about 100%. In 1981, America’s debt-to-GDP ratio was about 30%. As of January 2023, the US is spending $261 billion a year in interest payments – around 14% of total federal spending. In the UK, the Office of Budget Responsibility (OBR) says that interest payments on the country’s debt will cost £83 billion in 2022-23, more than 5% of total public spending, 2.5% of national income. While the US would find it impossible to repay all its debt, the UK could manage – just about.

Nor is it just about the ability to repay debts. Heavy indebtedness also harms economic growth; given that politicians are so keen on talking up the need for growth, it’s paradoxical that they don’t rein-in their spending. A 2013 study published in 2010 by the World Bank found that if debt is above a 77% debt-to-GDP ratio then “each additional percentage point of debt costs 0.017 percentage points of annual real growth”. Governments not only pay substantial amounts in interest, they restrict future growth by their reckless spending.

Debt servicing has become “more difficult” says S&P Global. There is “no easy way to keep global leverage [borrowing] down” it adds. A “Great Reset” of policymaker mindset and community acceptance is required, it adds. It offers two scenarios, a pessimistic and an optimistic. In the former, the projected global debt-to-GDP ratio is almost 400% by 2030; the optimistic is hardly more cheery – the ratio would be down to 321%, a pre-Covid level, by 2030.

Cutting spending in the midst of an expensive war is unlikely. This bubble will carry on inflating until it bursts.