Inherited debt?
With negative interest rates, debt is not a problem unless it causes a concentration of wealth.
As a result of the initiatives taken by governments and central banks to cope with the current pandemic, public debt has soared all over the world. This debt is often described as the result of the systematic trade-off between health and the economy. It has triggered a number of debates, mainly very lively, the main theme of which is the question of what world we are going to leave to future generations.
There are therefore many calls for the cancellation of the portion of this debt borne by central banks as part of their programmes to inject liquidity in order to lower interest rates and stimulate inflation.
Against the current backdrop of financial assets’ extremely high price, which attests to an almost blind faith in the foresight of governments and central banks’ actions, a default – even if organised – on government borrowings could be the last straw. A major financial crisis would become even more likely if the pandemic takes off again and non-performing loans on banks’ balance sheets could be expected to rise sharply.
In reality, the question of debt is a concern because it has been put the wrong way. Firstly, a traditional bank’s aim is not to get its loans repaid and reduce its balance sheet. It is in the business of wanting debtors to pay interest. With negative interest rates, debtors can pay off their debts’ load eternally.
Negative interest rates are of major significance, supporting in a certain way those who defend the theory of reasoned negative growth. They mean that savers should expect to see their investments fall in value in the medium term, in other words losing money on a recurring basis. Getting into debt today in order to spend today would therefore be the most rational decision to make under the current circumstances.
The third key observation is that government debt is not representative of the economy’s general level of debt; it represents the level of concentration of this debt among certain debtors.
The example of the United States shows that although government debt has risen sharply, the country’s overall debt remains below the percentage of GDP reached in March 2009. As per the above chart, the latest available figures (September 2020) show that this debt is 334% of GDP, following a peak of 365% in March 2009. And it should also be stressed that at the same time US household saving rate has jumped precisely as a consequence of government transfers, resulting in an increase in household wealth, which has at least equalled the increase in the country’s total debt.
Lastly, the central banks will continue to want to stimulate inflation and therefore inject liquidity on a massive scale: in Japan, the plan is to inject $700 billion, compared with around €2,000 billion in Europe, and $1,440 billion in the United States.
As the chart shows, buying up debt has become a norm in terms of conducting monetary policy, just like the level of interest rates or money supply in the past. In the case of the Fed, 34% of GDP will hence be frozen between now and end of 2021, compared with 50% for the Bank of England and 65% for the ECB. At the other end of the spectrum, the Bank of Japan’s total balance sheet has reached 135% of the country’s GDP. This clearly also relates to government bonds, but the BoJ has also bought up a lot of other assets such as equities. Most unexpectedly, since the Swiss government is not in debt, is the Banque Nationale Suisse with a total balance sheet of 154% of GDP in the third quarter of 2020. The BNS “only” buys currencies against the Swiss franc to counteract its rise. These currencies are then invested in government bonds – mainly US and European – but also, like the BoJ, in shares in various major listed companies. Lastly, the People’s Bank of China is quite an unusual case insofar as its total balance sheet has remained more or less unchanged since 2006 and has therefore decreased significantly as a percentage of GDP. China is in debt (over 300% of its GDP) but the government does not have very much debt (48% of GDP) and the central bank is still steering its monetary policy mainly on the basis of a reserve requirement ratio equal today to 12% of Chinese banks’ total balance sheets (vs almost zero elsewhere in the world).
This kind of statistics show is that our world can survive for a long time in this configuration, without the need to talk about defaults. However, governments will have to endeavour to deal with the highly toxic collateral effects of such developments, particularly with the distribution of wealth, a recognised driver of populism and social instabilities, as can be seen in Russia and Turkey, as well as in the United States, the UK and even in a largely redistributive country such as France.