Government debts are going through the roof! This year the U.S. debt is expected to rise by 15.4% of the GDP. The total U.S. debt will be bigger this year than the total economic output. Let’s explore together the different ways countries may deal with their soaring debt.

You can also watch my video “DEBT CRISIS 2020: How governments will solve the looming public debt crisis!” on my YouTube’s channel. Check it out!

The soaring debt, a harsh reality

First, let’s take a look at the situation. Since the COVID-19 pandemic started, the economy has ground to a halt. The question of the rising public debt was then rendered irrelevant. There is no other choice than to support both people and businesses. Because when we will get out of lockdowns and social distancing, if there are no businesses to restart, the economy will not be in recession but a depression. Nobody wants to have a depression on par with the Great Depression of the 1930s. So not only the already passed bills supporting the economy were necessary, but other rounds of massive spending will follow them.

It means that the debt-to-GDP ratio is going to increase sharply not only this year but at least through 2021.

By the way, I dislike the debt-to-GDP ratio. The Gross Domestic Product is the value of the entire economic output. Governments do not have access to the totality of this output. By using taxation, they control only a part of the wealth created. It is, at best, misleading to use either the debt-to-GDP ratio or the deficit-to-GDP ratio. It hides the horrific reality of the debt compared to the government’s income.

For example, in the U.S., the federal government revenue is around 17% of the GDP. Today, with the COVID-19 pandemic, the federal government is roughly spending $2 for each dollar it gets. It is a better view of the harsh truth than just talking of a deficit of 15.4%. Compared to its income, the federal government deficit is around 90%, so far. It may be worst by the end of the fiscal year.

The three ways to get rid of the public debt

However, even if today, the question of the debt is irrelevant, it will not be irrelevant in the long run. And how governments will handle it will have a significant impact on our lives. There are three paths to get rid of that debt, and governments will use one or more of those ways. Let’s explore them!

Increased taxation & reduced spending

The first path is increased taxation combined with reduced public spending. It is one of the ways countries like Greece have used to get out of their strangling public debt. You may not remember, but in 2010, we had the Greek government-debt crisis. For years they run their country with huge deficits. But in 2009, after the turmoil of the 2008 recession, they were unable to borrow anymore. The following tax increases have left Greece with Europe’s highest tax rates in many categories. And it was combined with drastic spending cuts. Greece was able to transform the deficit into a budget surplus in 2016.

Though the story does not stop here, the big consequence of all these austerity measures, the elephant in the room, is that Greek businesses are strangled by the high taxes, forcing them to lay off employees and cut wages.

This is a dire medicine, and I am not sure the U.S. government nor any government will want to go that way. Greece was arm-twisted by the IMF and its creditors. I do not see anything close to the same kind of treatment for the U.S.

Even if governments raise taxes, they must consider their effects on businesses. And about reducing spending, it may prove to be hard since the population may ask for more public expenditure on health care after the coronavirus pandemic.

Besides, more spending is necessary in the U.S., because infrastructure is old and in bad shape, and not fixing or replacing it may cripple the economy later. 

Defaulting on debt & promises

The second path governments can follow to deal with the debt burden is simply defaulting, not paying it back, at least in part. Greece, for example, defaulted on its debt. Creditors renounced to be paid back in full in exchange for the harsh austerity measures I talked about earlier. Some small or developing countries will probably default.

However, it will probably not happen with developed countries like the U.S. Financial sector, and, in consequence, the real economy would get a devastating blow if the U.S. defaulted on its bonds. And it would propagate instantaneously to the rest of the world. It is simply unimaginable.

Though, it is conceivable for developed countries to “default” on promises they made to the population. For example, pensions not keeping pace with inflation, or even cut down, are not considered as a credit event. But since those promises have a present value, altering them may lower this value. Kenneth Rogoff, a professor of economics at Harvard University, concluded that commitments like pensions and health care could be viewed as a debt, and defaulting on them is more manageable than defaulting on bonds.

Growth & inflation

The last path governments can follow to wash away the burden of this debt is to wait it out. Growth and inflation can lower the load over time. It is a path that was followed before, especially after both world wars. After the world wars, countries all around the world had a lot of debt. The U.S. had a debt-to-GDP ratio of 112% at the end of the World War 2. Besides high taxes, America used a combination of growth and inflation to ease the burden of the debt. The total public debt went as low as 31% in 1974 and stayed low until 1981 when it started to rise again.

Waiting out is then a solution, but it takes a lot of time.

I see two issues with the growth and inflation solution to the debt problem: the current debt addiction, and the inflations’s wealth transfer

The debt addiction

First, since the 1980s, debt is growing in developed countries. Before the COVID-19 pandemic, we had the highest level of public debt in peace-time. We could even say that developed countries are addicted to debt, both public and private. Now we will reach a level of debt unseen since World War 2. We live in a permanent debt bubble since the 1990s, and this trend of growing debt seems to be unstoppable. If you have an idea of how to stop it, maybe you should contact your senator, or even better, leave a comment below.

Moral Hazard & wealth transfer

Secondly, and I will come back to history for this one, inflation brings its share of issues. It unduly rewards moral hazard and reckless behaviors, for example, taking-on debt to pursue share buy-backs or taking irresponsible amounts of debt. Inflation erodes the value of money, so those economic actors owe less, while at the same time, prudent businesses or persons see their actions penalized. The other big issue, experienced by U.K. citizens after World War 1, is that wages do not necessarily grow in par with inflation. Inflation was transferring wealth from the poor and middle-class to the wealthy. Since today we have an inflated gap between the wealthy and the rest of the population, this effect should be carefully considered.

Share your thoughts, and thank you!

Don’t forget to share this post. You can also subscribe to my YouTube’s channel! Thank you so much for your support!

Question of the day:
How do you think the high level of public debt should be managed?