The Burden of Debt

Both ends of the political spectrum have become increasingly cavalier about debt. They may live to regret it.

A spectre is haunting the world. No, not communism, which can’t even find a home in Russia. The spectre is debt. The creditor class has nothing to lose but its Kapital, and the bourgeoisie nothing to lose except the value of all that it owns. As Vladimir Lenin once said, “the best way to destroy the capitalist system is to debauch the currency”-subject it to an unsustainable level of government debt, then increase the money supply such that the value of the currency drops sharply. Think Weimar Germany, Mugabe’s Zimbabwe, Maduro’s Venezuela, where carts replaced wallets and purses as shoppers’ means of transporting paper money.

In America, the government’s outstanding debt tops $22 trillion and is rising at close to $1 trillion per year, soon to exceed even that level. The Congressional Budget Office (CBO) estimates that the federal debt held by the public, now at 78 percent of GDP, will rise to 92 percent in 2029. And that statistic assumes that Congress, in an unusual display of fiscal responsibility and political heroism, does not extend the Trump tax cuts that are due to expire in 2025. More likely, tax-cutters will be on as thin on the ground in 2025 as they are now, and government debt will exceed 100 percent of GDP. Harvard economists Kenneth Rogoff and Carmen Reinhart studied data on the relation of growth to debt in 44 countries spanning about 200 years and concluded that when the ratio reaches 90 percent, growth significantly declines.

America is not alone in choosing profligacy over prudence. Between 2008 and 2017 global financial debt rose from $97 trillion to $169 trillion according to McKinsey & Company. Stephen Jen, CEO of hedge fund Eurison SLJ Capital, believes “the debt load in the world is so high now that it can’t withstand any historically normal size of interest-rate increases anymore.” David Malpass, the president of the World Bank, agrees. “There is too much debt floating around the world,” he told the media upon taking office. Much of that debt consists of loans by China to countries unable to carry their debt load and forced to turn over collateral-ports and other infrastructure-to the People’s Republic, much to its delight.

The International Monetary Fund warns that the high level of global debt threatens to amplify any economic downturn. That would cause pain not only to the parties to the loans, but to innocent bystanders, the collateral damage of any downturn.

If investors come to see the nation’s debt load as unsustainable, they will demand higher interest rates to finance ongoing deficits. And, warns CBO director Keith Hall, “It is hard to imagine this is sustainable.” But Hall is an old-fashioned deficit hawk, a species close to extinction in our politics. These hawks believe that government borrowing drives up interest rates, making it more costly for private sector borrowers to finance mortgages and business investment. The result is slower growth and, if things get out of hand, stagflation, a combination of no growth and high inflation.

This belief is now under siege. From the far left of the Democratic Party to “respectable” academic economists, a reappraisal of the role of debt and deficits is underway. Enthusiasts for Modern Monetary Theory, or MMT, have varying definitions of what it might mean in practice: Broadly stated, they claim that so long as a country has its own currency, it can run deficits almost indefinitely. All it must do is print money to cover the gap between spending and tax revenues. That policy needs to be reversed only if inflation rears its dangerous head. For obvious reasons this appeals mightily to Vermont’s Bernie Sanders, the socialist vying for the Democratic presidential nomination, the man whose academic advisers rescued the theory from the dustbin of history and coined its name. And charismatic, self-styled Democratic Socialist Alexandria Ocasio-Cortez is popularizing her own version of MMT, which she believes would make the printing presses available to fund her Green New Deal, Medicare-for-All, student loan forgiveness, and-well, you get the idea.

Republicans, meanwhile, are crying that these “socialists” will bankrupt the country. Trump sees no inconsistency between his attacks on profligate spenders and his own plan for still more tax cuts, coupled with a $2 trillion, “not typically Republican” infrastructure program. Soaring deficits, it is argued, are not inconsistent with budget probity. Tax cuts and spending plans will so increase the rate of economic growth that tax revenues will rise sufficiently to offset any revenues surrendered by cutting taxes, and then some. This theory has not been validated by actual experience, or by scholars. But MIT professor and president of the American Economic Association Olivier Blanchard claims the U.S. situation, in which interest rates are below the rate of economic growth (not adjusted for inflation), “is more the historical norm than the exception. If the future is like the past. . . .the issuance of debt without a later increase in taxes may well be feasible.”

Keynesians have always held that deficit financing is appropriate in cases of high unemployment. Neo-Keynesians such as Harvard’s Larry Summers go one step further: Even at full employment, if interest rates are so low that the payoff from public investment in infrastructure and social projects is higher than what the government pays to borrow the necessary funds, the borrowing makes sense.

But Summers and Harvard colleague Jason Furman cannot take the next leap to MMT: Although “the deficit dismissers have a point. . . .the deficit fundamentalists are right that the debt cannot be allowed to grow forever.” Of course not, forever being a very long time.

The U.S. government is not the only institution rattling its begging bowl because it spends more than it takes in-“earns” is not quite the right word. Between the end of the financial crisis and 2017, the total global debt of non-financial corporations, including bonds and loans, more than doubled, growing by $37 trillion to $66 trillion. Business debt grew faster than GDP in that period, according to the Fed’s latest Financial Stability Report, issued earlier this month.

This was an understandable response to low interest rates, or, in the vernacular, cheap money. But if interest rates start to rise, meaning bond prices start to fall, the holders of these IOUs might start to dump them, creating a downward price spiral. The government might find interest payments sopping up so much cash that it has difficulty meeting its security and social-policy obligations without printing the necessary money. Companies with strong balance sheets-relatively low debt-might survive the pressure of higher rates. Unfortunately, the most rapid growth in debt over recent years was concentrated among the riskiest firms, the most indebted of all. They benefitted not only from low interest rates, but from declining credit standards. Former Fed chair Janet Yellen warns, “If the economy encounters a downturn, we could see a good deal of corporate distress. If corporations are in distress, they fire workers and cut back on investment spending…. That’s something that could make the next recession a deeper recession.”

Finally, the aggregate debt of developing countries is near its highest level in over a decade. If the dollar rises relative to their own currencies, they will have to pay more for the cash they need to cover their interest payments and essential imports. That is the stuff of which defaults are made.

So far, the music of growth, low interest rates, and deficits plays on. When it stops, one astute observer of the financial scene told me, there may be no chairs at all on which a weary policymaker can take a moment’s rest. Brian Riedl, a senior fellow at the Manhattan Institute, estimates that this year the government will spend $35,148 per household and collect only $26,677-nice for us, not so nice for our children and grandchildren. That $8,471 gap must be paid back somehow, some day. Summers and Furman, not ones to obsess about budget deficits in the here and now, concede that “running budget deficits does not replace the need to raise revenue or cut spending. It merely defers it. Sooner or later, government spending has to be paid for.” Sooner if by your children, later if by your grandchildren. Herbert Hoover had it right when he told the Nebraska Republican Conference in 1936: “Blessed are the young, for they shall inherit the national debt.”