by Elliot Campbelton
Sept 2020
As most of the news talks about enforcing mandatory lock downs and handing out money to citizens there has been a problem gaining headwind in the background.
The debt legacy
During World War II Britain was in the thick of war against the Axis powers, however Britain was running out of money so they began looking to borrow money from both their own future taxpayers as well as the United States and Canada.
Britain began accepting loans and taking on debt to fund the war, and by the end had taken on nearly 10 billion dollars worth of debt from its creditors. At this point in time Britain's debt to GDP ratio was a whopping 200 percent meaning that the country had twice as much debt relative to the value of the economy. For some perspective, the World Bank states that once a country reaches above 77% debt to GDP ratio its economy will begin to slow down from such a large portion of its revenue going towards paying down its own debt.
After the war ended Britain had amassed a debt so large it would be impossible to pay back before the end of the century. Only on December 29th 2006 Britain made its last payment on its World War II debt to the United States and Canada.
Despite the crippling dept, in the years following, the UK economy was saved by an influx of tax payers in the form of the baby boomers as well as economic reforms and in for structure investments.
No tall so lucky
This should not be a blueprint for advocating large public debt, others in the more recent past have not been so lucky, in 2001 Argentina's debt to GDP ratio reached a high of 166% which caused the country to default on over 100 billion dollars worth of debt, causing capital flight out of the country, giving rise to millions entering poverty while unemployment reached a high of 19 percent. Similar stories can be observed around the globe , from Greece in 2012 to Zimbabwe , Venezuela in 2017 and Russia.
Debt in a crisis
While debt is a necessary part of economic growth and to evade the worst elements of a crisis, using the mechanism has long-term consequences that could last for years or even decades. Considering the US which in 2006 had a relatively healthy debt to GDP ratio of about 60%. When the financial crisis hit the US began pumping money into the economy (over 2 trillion dollars in total). Many people may assume that this debt, accrewed over ten years ago, might, at least in part, have been payed off, but in truth it is the opposite.
Sky rocketing national debt
Since the financial crisis many developed countries throughout the world have been accruing more and more debt every single year while economic growth has slowed. This means that many countries may find it more difficult to pay off their debt today than they did during the financial crisis.
Considering again the relation between debt to GDP, before the crisis, the US stood at 106%, Canada's was around 88% Italy's was 133%, Singapore's was 109% and Japan's was over 250%
This brings up the interesting scenario for many countries, like the United States, who will accrue significantly more debt in the next few months, with the only conceivable options to pay off the debt being, Grow, Tax , Refinance (raise the debt sealing) or Default.
While it is highly unlikely that developed countries like the United States, Canada or the UK will default on its loans which would send the countries into an even deeper depression, it is quite clear that the debt that's being accumulated today will end up slowing future economic growth, raising future taxes, and reducing future funding for social programs.
This effect will likely radiate for decades to come, meaning that the youth of today will be paying for a decent portion of the stimulus packages issued this year when they become adults.
Non Government debt is an issue too
The second important factor here is that government debt is not the only debt problem. Before the crisis ever began households were already racking up record levels of debt. In 2020 households in the United States had roughly 14 trillion dollars worth of debt (which is the highest debt level in history). The largest case of this can be attributed to student loans. In 2008 student loans accounted for roughly 611 billion dollars worth of household debt, today it is roughly 1.6 trillion dollars, which when considered on aggregate roughly nets out at $100,000 worth of debt per household.
Meanwhile these same households have on average only $8,000 worth of savings, and for people under the age of 30 it's even worse ($2,700). That according to government statistics is just enough to cover one month of housing food and insurance for the average person.
This means that going into this crisis the average person was already living paycheck to paycheck with little to no savings and a considerable about of debt. So the recently announced 1200 dollar stimulus checks might be able to help some Americans get by for an extra week, but it won't be good enough for a long-term solution.
No good solution
The only way to help people avoid missing rent payments defaulting is to lift lockdowns, which risks lives. Hence, given we are in an election year, prescribing the mophine jab of credit injection to beleaguered American households, is the more politically palatable move, but does come at a cost.
Zooming out as more and more households fall subject to unemployment, individual and national debt will need to pile up still further in order to maintain the socio economic levels as they are.
However this problem might be a lot worse in the short term for developing countries. The IMF and World Bank have called for an immediate suspension of debt payments for the world's developing countries as many are very close to defaulting on their debt.
What is clear, is that the pervasive use of debt, to alleviate short-term hardship, under the guise of being most politically expedient, as a global narrative for many governments around the world, sees an escalation of the propensity to saddle future generations with debt, with an ever shrinking toolkit for servicing that debt as the years roll on.