Why governments are 'addicted' to debt | FT Film

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Government borrowing is the biggest issue in finance today.

Governments around the world are addicted to debt.

The sovereign debt levels globally have just grown exponentially.

In the case of the developed countries, the average ratio of public debt to GDP is now back to where it was in 1945. That’s rather striking.

It’s politically impossible to solve.

Exploding debt is a real worry. If you’re an investor you start wondering what’s going to happen and whether there’s going to be a debt default.

The music stops when you get a major crisis.

The big question is, at what point does the bond market break?

We just don’t want the bond yield to get up to a point where it crushes the economy, because then the bond vigilantes will have taken their vengeance.

A determined central bank can always override any market pressure.

I think bond investors should be terrified.

Let’s face it, the world is addicted to debt. Pretty much every country, OK, leaving Germany aside, has very large amounts of government borrowing.

We’ve started to take it as so normal now that governments borrow enormous amounts of money relative to their GDP.

The US, Japan, Canada, Italy, France, all of these countries have very high debt levels by historical standards.

Wherever you look you see problems of government debt or deficit. The US, where the deficit is about 7 per cent of GDP. China also has a very large deficit.

It’s a playbook that we’ve seen going back at least to the global financial crisis. You borrow your way out of trouble, and the way that you pay for that borrowing is more borrowing. And we don’t seem to have a way out of this cycle at the moment, at least in some of the biggest economies in the world.

In the case of the developed countries, the average ratio of public debt to GDP is now back to where it was in 1945. That’s rather striking. A great deal of this has to do with huge shocks.

So the global financial crisis. Then we had Covid. Then we had war in Europe. And each time governments have found, quite correctly, they need to be, as it were, the insurers of last resort.

Following Covid we had this global spike in inflation, interest rates going through the roof. That means much, much more expensive debt servicing costs, debt interest costs for government.

Debt to GDP levels are roughly 100 per cent, so the same amount of debt as these economies produce every year. The projections are they rise, rise and rise to the point where it gets a bit explosive.

My name is Olivier Blanchard. I’ve been a professor at MIT all my life, but I took a leave to go to the IMF. I joined in 2008. I had to deal with global financial crisis and then the euro crisis. There’s a number of countries which are addicted to debt, and I think the disease can hit any country at any time.

I’m Ray Dalio. I’m the founder of Bridgewater Associates, the largest hedge fund in the world. I’m a global macro investor. When debts accumulate and interest payments accumulate, the debt service payments squeeze other spending. And it’s a particular problem when there’s a need to borrow money in order to make debt service payments. And the spiral begins.

Bonds are effectively an IOU. It’s a way that the government can say to an investor, OK, you lend me this amount of money for this amount of time and I will give it back to you after that amount of time. And in the interim I will pay you interest payments called coupons.

Now, because there are loads of different bonds, they’ve all got different maturities, they’ve all got different coupons attached to them. It can be a little bit difficult to compare apples with apples. So to do that what we do is compare the yields that are available on bonds.

Yields go up when prices go down. What governments generally don’t want is for yields to go up too quickly or too fast, because that jacks up borrowing costs for everybody around the country. That’s why you need a good bedrock of support, of buying support for bonds.

One man’s debts are another man’s assets. So in order to hold the debt it has to be attractive. Then there is what some people call the debt death spiral, which means that there’s selling of debt when there’s worry about that.

People have been warning that this is getting out of control. That drumbeat is definitely getting louder now. We have seen the odd episode where it’s looked like investors are saying, we’re not buying any more of your bonds. That’s when people start to get really jumpy.

I’m Karen Ward. I’m the chief market strategist at JPMorgan Asset Management. So my job is to advise clients on what’s going on in and around the world and help them make the best investment decisions.

The level of government borrowing is certainly one of the top questions I get asked amongst clients today. Government debt is supposed to be our safe haven asset. It’s supposed to be the bedrock of our portfolio. It’s supposed to be the boring bit.

I’m Greg Peters, co-chief investment officer of PGIM Fixed Income. From a bond investing standpoint, what I worry about is inflation, right? And so inflation on the rise is just so difficult from an overall portfolio standpoint to protect yourself.

Bonds hate inflation. It’s like kryptonite for them. They just can’t live with it because it eats into their returns.

In a world where we’re also being met with inflation shocks, then the role of government bonds as that safe haven diversifier that many investors look to isn’t quite so clear.

There are times when an increase in debt is completely justified, wars or preparing for wars, or Covid. These are cases where you have to spend more. What we have seen in many countries is not that. It’s basically just tomorrow is another day type behaviour.

The world has been addicted to debt because debt has been for free. So we’re coming out of this zero negative interest rate world where there’s been nothing but encouraging taking on more debt.

I’m Stephanie Kelton, and I’m a professor of economics and public policy at Stony Brook University. I do a lot of public speaking – finance, hedge funds, investment bank. That’s my crowd. I can poll them before I go in and say, how many people think we should be reducing budget deficits? Almost every hand goes up. How many people are worried about the national debt? Almost every hand goes up.

When I put this graph up everything changes. This is the United States of America. The government has been running deficits for virtually my entire life. But look up and they see surpluses in the rest of the world and surpluses in the US private sector.

If you want to eliminate the government deficit, you’re going to erase all of the other surpluses because the one is creating the other. The government deficit is doing something very useful, which is creating a surplus, allowing the rest of us to net save. Their red ink is our black ink.

My name is Russell Napier, an adviser to investment institutions. One of my joys is also to be the keeper of the Library of Mistakes, a business and financial history library here in Edinburgh. There is an issue with there being too much borrowing in the government sector, but it has to be seen in conjunction with too much borrowing in the private sector. If we lived in a country where government debt to GDP was high, but private sector debt to GDP was low, then the consequences of this government debt addiction would actually be quite different.

Private borrowing and private debt, and private markets are, in my view, just as big a problem. Really big private busts cause explosion of government debt. After the financial crisis until the pandemic, and really a year or two after the pandemic, all we were worried about was inadequate demand and deflation. That was a world in which monetary policy was aggressively stimulative. Inflation has come back and inflationary pressures seem quite strong.

When you’re dealing with governments’ requirements and the political system, there’s a desire for spending. When you get credit and you can hand things out on credit at that time it’s better. Credit produces debt.

One of the ways we tried to deal with that situation for the last decade was to try and cut back on other areas of spending, but that’s actually left us with a new problem. We haven’t been committing enough to public services, public infrastructure. And you can see that the pressure is on governments around the west to, if you like, make up for the lost spending that happened during the decade of austerity.

You’ve got all these pressures which are building up. We’ve got quite weak growth. So you don’t have hugely, rapidly growing tax revenues.

You’re gambling with World War Three.

A more uncertain global security world. Defence is going to become more of a priority, not less. An ageing population. There’s a green transition now. A lot of that needs some sort of public support to make it happen faster. And we’re likely to see interest rates much higher than they were before. And that adds an additional burden.

We’ve now got to the point where it’s pretty normal for governments to borrow on a kind of crisis pace every year.

In a world of low inflation you can get away with this. Bond investors will fund you and fund you and fund you. But in a world where it is not likely that inflation stays low, that is when time is called upon the whole thing. Supply and demand are running headlong into each other.

The bond market was the ultimate arbiter, right, of fiscal responsibility. The bond vigilantes, so to speak, step in and actually focus the mind of politicians.

I’m Ed Yardeni. I’m the president of Yardeni Research, focusing on global macroeconomic and financial markets. I’ve been doing this for over 45 years, and when I first wrote about the bond vigilantes in July of 1983. And during the 1970s bond investors got killed, inflation soared and bond yields went up dramatically.

And I argued that if the fiscal and monetary authorities were not going to maintain discipline that the bond vigilantes would take over, and they would push bond yields up to levels that could slow the economy down and bring inflation down. We just don’t want the bond yield to get up to a point where it crushes the economy, because then the bond vigilantes really will have taken their vengeance.

We’ve seen all this rise in debt without the bond vigilantes stopping it, with a few exceptions. So what did we see in 2022 in the UK? The bond markets decided that the Liz Truss government didn’t have a clue.

Our gift to the world is showing everyone what can go wrong if you push the bond market too far.

Mr Speaker, I am a fighter and not a quitter.

Bond investors talk about Liz Truss moments. We all remember back end of 2022, Liz Truss and her chancellor Kwasi Kwarteng effectively blew up the gilts market. Prices fell incredibly quickly, triggered a lot more very aggressive selling and it all got out of hand very quickly. And it took the Bank of England to steady the ship.

Governments around the world live in dread of doing that to their bond markets, because immediately you could see in the UK during that episode that borrowing costs went through the roof, people’s mortgage costs went through the roof. Bond markets matter in real life because it really hits the average household in the pocket pretty hard.

The UK is front and centre in many respects around the concerns of debt sustainability.

So I don’t think it’s particularly a fiscal credibility problem here in the UK. There are questions over the long-term growth prospects here.

We don’t want to get this out of proportion. There isn’t a UK markets crisis happening right now like what we saw two or three years ago with Liz Truss.

This government inherited quite a relatively tight fiscal position. Maintaining fiscal tightness is going to be very difficult because the pressures for spending are just so strong.

The big question is when the big boy here, the US, which has the biggest deficit, has completely unsustainable debt profiles, when do the bond vigilantes take against the US?

The US is really at the heart of this entire issue. It’s the lynchpin of the global economy, its bond market is worth more than $20tn. It has a bigger deficit than most western countries. And then you have Donald Trump coming into office.

Worst case, you’re looking at 10 years forward, 160 per cent debt to GDP. That is an eye-popping staggering number.

The US federal government spent $880bn on debt interest last year. That’s four times the level of a decade ago. And it’s more than they spend on the military, almost as much as they spend on health. If the way that you pay for debt is to issue more debt, you’re vulnerable to a rise in interest rates. And that’s exactly what’s happened.

It’s approaching 25 per cent of all revenues just to pay back the debt. And that is the classic debt trap, right? It’s a hole that you can’t dig out of and you can’t inflate your way out.

Well, the US is running an enormous deficit, about 6 per cent of GDP, which in peacetime at full employment, remember, is extraordinary. I mean, it’s absolutely enormous. And the trajectory for US debt, if you look at standard forecasts, I mean, it’s very, very disturbing since it’s the most important country with the most important currency.

The projected amount of debt that has to be sold, which equals the deficit, is 7.5 per cent of GDP. And at existing interest rates that raises also debt service a lot. So it’s right at that precipice.

I think the way that you address this issue is you make a bipartisan cross party lines commitment to 3 per cent of GDP.

People are so conditioned to hear the word deficit and think it’s a pejorative. And what I think we have is a linguistic problem. We’re using words like deficit and debt to describe things that are really quite benign.

When people say they’re very worried about the government deficit, what they’re saying is I’m very worried about the financial surplus that’s in the non-government part of the economy. Call it the net contribution instead of the deficit. Call it the cumulative net contribution instead of the debt. The temperature would come down a lot if people understood that the thing we’re fighting over is our financial surplus and our savings account.

The Trump administration, once they realised that they were going to go into the White House, they had to at least make some effort to satisfy the bond vigilantes. And so suddenly we have the DOGE department, the Department of Government Efficiency.

And they’re also going to address the deficit. So we’ve got a $2tn deficit. And if we don’t do something about this deficit the country’s going bankrupt.

Maybe this Department of Government Efficiency, which Musk is supposed to head, will somehow find enormous savings, which will be enacted. I’m very, very sceptical that there’s anything there which will be big enough to offset likely tax cuts.

Elon Musk was kind of… I think it was asked during the campaign, how much do you expect to cut off from the deficit? And he right away blurted out $2tn. Even he’s backed off on that.

I’m sceptical that Musk will be able to reduce spending sufficiently to decrease the deficit by any substantial amount. It would take some hiccup in bond markets, in the Treasury market to actually lead Congress to be slightly more responsible.

The US is crucial to the global financial system. The dollar is the world’s currency of trade, of cross-border debt. People in other countries, big investors, central banks, they need to hold dollars. That means they need to buy US government debt. It’s the benchmark safe asset for the whole world.

Now, that has enabled the US government to be more free spending than most others. Maybe the type of crisis that we’ve seen in the UK or in the eurozone a decade and a half ago could eventually come to the bond market. The economy that is at the centre of all of this.

It could be really the most significant fiscal monetary problem in the world, and it could trigger destabilising events in financial markets.

I did see a post from President Trump, two words all caps, balanced budget with tax cuts and a lot of spending on border and other things. I think it’s more likely than not that we’ll see large deficits continue.

On the flip side, we’ve also seen, with a country like Japan, that you can have very, very high government debt levels for a very long time and really nothing bad happens. The key to Japan’s success, if you like, is that their very high debt levels have been accompanied by economic stagnation, where the central bank keeps interest rates very low, and also does quantitative easing, where it buys up all of the debt. So it doesn’t really enter the market.

And you have the currency depreciate by 4 per cent a year, so you lost about 70 per cent relative to US bonds. It’s going to be a bad deal.

The bond vigilantes, if we want to be honest, they’re the central bankers. A determined central bank can always override any market pressure to move yields higher, as the Bank of Japan has clearly demonstrated.

The unique thing about Japan is that the creditor of the Japanese government is the Japanese people. They’ve been prepared, it’s mostly the corporate sector, to hold Japanese government debt at zero yields, despite inflation. And the Bank of Japan is a highly trusted institution. I wouldn’t be surprised if there were problems at some point, but they do have the most trusting and most solvent creditors in the world, namely themselves.

For the most part this is a western problem. This is a problem in developed economies. But if you look at a country like China, for example, a lot of people now are drawing parallels between China’s economy and Japan’s 10, 20, 30 years ago, talking about demographics, ageing populations, debt levels going up.

You look at the debt levels in China. It’s staggering. And I think that has real implications. It’s a closed system. They’re not growing in the same way that they have before. The remedies just aren’t really available.

You could be seeing a situation there where these kind of existential worries about debt become, become an issue too.

The eurozone’s public finances are rather stronger than those in the UK or the US or Japan. But the eurozone is not a cohesive picture by any stretch of the imagination.

Italy is one of the biggest borrowers, if not the biggest borrower, in the euro area. France, just politically, has a really difficult time reining in spending.

And in France there are plenty of issues that we have to confront, including the deficit and the debt. And so I’m involved in those discussions. The debt level is high, but it’s increasing. And that’s what worries me. I think we have to at least stabilise the ratio of debt to GDP. And that’s a big number.

I mean, to do this under the best assumptions that I can make, it’s 150bn that we have to find in the current political environment, that’s absolutely impossible. It may well require the kind of crisis which makes people sit down and be willing to accept cuts. And without it, I’m not sure we’ll get there.

You’ve got an additional element here, which is Germany, the poster child for limited spending, limited borrowing, one of the safest and frankly, most boring bond markets on Earth.

Germany’s new chancellor has reached a historic deal to spend hundreds of billions of euros on defence and on infrastructure. Now, this is a huge change. We’re talking about an economy that has historically been very reluctant to borrow heavily. So in a sense, Germany is belatedly joining the global debt party.

They need more domestic demand. And the private sector runs a huge surplus in Germany, doesn’t generate demand adequately, has to spend a lot more on defence. We all know it. Its growth is very slow. It needs a lot more public sector investment. Investment has been very weak. If you need a defence build up, you need to borrow. That’s what governments are for.

Whilst the rest of the world have been spending, whether that’s cheques in the post in the US during Covid, huge support for industry like we’ve seen in China supporting its electric vehicles. We haven’t seen the same behaviour in Germany, but it’s paid the economic price for its prudence.

It’s really struggling to compete with some of those car producers in China that, thanks to those subsidies, have reached massive economies of scale. The consumer in Germany, not having had those cheques in the post, is much more cautious, hasn’t been spending.

The investment community has been crying out to Germany to borrow for the last decade and a half. They’ve been reluctant to do so. Now that they are, as I say, belatedly joining the party, people are assuming this will be great news for the German economy. Great news for the European economy.

Debt is not always bad. That’s the important thing to remember here.

Italy is a bit different from France. It has a high level of debt, but again between 100 and 130, what you have is a prime minister who actually is fairly responsible from a fiscal viewpoint. One of the reasons is that a lot of money from Brussels is conditional on good behaviour. Italy is behaving fairly well.

The bond vigilantes have never been potentially more powerful simply because there’s a lot more debt. Whether the politicians get the message is a whole other story.

We have to get the government deficits down to a level so the debt doesn’t rise relative to incomes. If it’s not done like that you will have a high risk of a financial market heart attack.

You just can’t say at x per cent, that’s when the bond market’s going to wake up. That lack of clarity around an exact number is the problem.

That’s the thing that really worries investors, because there’s nothing they can do to hedge against it or prepare for it.

The big risk is what we saw in the 70s, the government said it issued debt in their own currency, very rarely default. With the Trump administration possibly at war with the Fed, that could look quite plausible in a year or two. And if that happens then the bond market would certainly break. You get high interest rates, high inflation, and in the end the inflation wipes out the debt. And that should make the investors very worried.

Something’s got to give. Either bond investors have got to be convinced somehow to just chew down on returns that they really don’t want, or governments have got to massively cut their spending.

Austerity isn’t going to happen. It may be a market impulse to go for a debt spiral, but governments would not permit it.

These so-called vigilantes are backed because they can see a world going forward where there’s more inflation. My opinion on the vigilantes is that they will be assassinated. Now, this is what we did after World War Two.

We didn’t allow the market to determine the price at which the governments would pay for credit. We forced people to buy government bonds, keep those yields at rates that any vigilante would consider obscenely bad value, to prevent the debt spiral and a death spiral. Whether we live in democracies or whether we live in dictatorships, the dictation will be to the vigilantes, not the vigilantes dictating to the governments.

There’s a real debate between economists. Some people will say the bill is falling due. Something bad is going to happen if we don’t cut debt soon. Other people will point out that, actually, government finances are not like household finances. You don’t have to pay your bills because you control the money printing machine.

The problem with that is that it’s inflationary. So there’s no zero cost way to sort this out.

If you don’t like the fact that there’s a large and growing Treasury market, you could always make the decision to stop issuing more Treasuries. It’s a policy choice. It’s not an economic imperative that the government issue securities to match the deficit each year.

You don’t need to get rid of government debt. All you need is to stabilise it at some level that your population and your lenders think is reasonable.

Deficits can be useful. When the economy goes down, right, there is a recession, then it’s clearly a good idea to have a larger deficit, a larger deficit when times are bad and a larger surplus when times are good.

Public finances have to be sustainable. The wrong way to get there is to have a massive, sudden fiscal shock and tightening. That was the great mistake after the financial crisis with austerity. But we should be sure that they’re sustainable and that we should be sure that the public finances support growth.

If you simply take the view let’s borrow as much as we can, then you’ll find yourself with this problem in the private sector. Now, there are other people in that camp who say, well, that’s really easy because we just fund it by printing more money. Well, there’s a long, long, long, long, long history of how that is disastrous. Now, I know those people will argue that it will not be like that this time.

I think any financial historian finds it exceptionally difficult to see how the government, direct government financing by the central bank is anything but heading to very high levels of inflation. But, big but, there are plenty of savings in the world, and the government’s going to manipulate those savings to borrow more money, but it’s going to borrow that by forcing people to buy those government bonds.

I don’t think they take the radical approach that some people recommend of direct funding of the government by the central bank. You don’t have to take that risk. The world is full of savings. You can abuse the savers long before you have to abuse the balance sheet of the central bank.

I can’t see a way for governments to snap this reliance on debt.

The countries which have large deficits are going to go through tough adjustments. The notion of fiscal rules will come back.

No panics. Panics are the worst thing you can do unless you’ve got an absolutely overwhelming immediate crisis.

Everybody wants more credit. And politicians particularly like borrowing and spending because the paying back comes in somebody else’s term.

And if you can increase spending without increasing taxes and get away with it, that’s nirvana. And there’s only one problem is, well, how about the bond vigilantes? Maybe they don’t want it, and maybe they have the power to stop that.

So there are big debt cycles that go on for 50 or 75 years, in which debt is rising relative to the income needed to service that debt. Policymakers need to understand the big debt cycle. Are there limits to debt? What are they like, mechanically? Yes, because it will come.

Every government deficit is good for someone. Is it a deficit that is resulting from passing tax cuts that primarily benefit people in the top of the income distribution? That deficit is going to be very good for that cohort of people. Or is it a deficit that is the result of making investments in your healthcare system, your education system, your infrastructure. That can increase the deficit as well and serve a different constituency.

Inflating away the debt by stealth over a period of many, many years may turn out to be the least worst option here, or at least one that allows politicians to avoid making some very, very unpopular decisions. But higher inflation, I mean, as we’ve seen in recent years, is very unpopular and can also lead to governments being thrown out of office.

Inflation has to be unexpected. If inflation is expected, then bond yields go up and actually governments don’t improve their debt situation.

I can’t imagine a world easily without government debt. Government debt has been a feature of economies for centuries. The modern financial system in the UK was created with the creation of the Bank of England, and that was there to help the government manage its debt. The government is the soundest credit and it does long run things. There’s nothing wrong with borrowing. It’s part of what makes a modern financial system work.