Debt is an omnipresent and ubiquitous problem. Both public and private debt have been critical to generating growth since the dawn of civilization. But too much (especially when it’s private) can slow the economy. The burden of servicing debt depresses real incomes and also creates greater inequality because owners of capital benefit disproportionately, since debt tends to push up asset prices—at least until the bubble bursts.
We’ve been hearing a lot on this topic lately because of the debate in Washington over the debt ceiling. Republicans’ concerns about the level of the U.S. government deficit have been overshadowed by the fact that they have focused so much of their negotiations on highly politicized issues, such as defunding the Internal Revenue Service.
In any case, the federal budget area up for grabs represents only 15 percent of total spending. The result is that instead of rising to 119% of GDP within a decade, the federal debt will rise to 115%.
So far so small. Ignored in the heat and noise of the debate is the fact that the debt created by the government sector translates into growth in the household sector.That’s the view Richard Wager, a former banker and now secretary of the Commonwealth of Pennsylvania’s Department of Banking and Securities, makes in his forthcoming book debt paradox.
Vague noted that the U.S. federal deficit hit $3 trillion during the 2020 Covid pandemic as the government acted to help save the U.S. economy — and, to some extent, the world economy. Meanwhile, the wealth of the nation as a whole rose by about $11 trillion, thanks in large part to a $14.5 trillion increase in the net worth of U.S. households in the same year.
In fact, if you look at the full three years of the pandemic from 2019 to 2022, government net worth fell by $1.7 trillion ($6 trillion at the federal level), while household net worth rose by $30.9 trillion Dollar. That’s true even after taking into account last year’s stock market decline.
Why? Since the 1980s, these assets have increased along with public and private debt, as government debt is translated into household income and asset wealth from stocks and home values has increased. “Quite simply, debt is necessary to create GDP growth,” said Vague, explaining why the total debt-to-GDP ratio in the U.S. and in all but two of the world’s seven largest economies has fallen since the 1950s. synchronized rise.
He called this the “government debt and spending pattern,” in which the proceeds of government spending flow to nonfinancial businesses and households. This happens to varying degrees – in the US, for example, earnings go mostly to households, while in Japan they go mostly to non-financial corporations. Notable exceptions to this pattern are Germany, which relies on trade surpluses to fuel growth, and China, where non-financial sector debt boosts household income.
The conclusion is basically that debt begets growth. So why worry about it, public or private? Because debt can also cause problems.
The first problem is that rising debt leads to rising inequality. This is because higher asset values are mostly held by the wealthy. In the US, this has been especially true since financialization really took off in the late 1980s. Even when incomes are rising, when the price of housing, health care or education exceeds wages, you can have a cost of living crisis (as is currently being demonstrated in the US and many other parts of the world).
The second problem is that rising private debt is a drag on the economy, as household debt repayments become an increasing burden for those who are less well off.
Debt-driven growth cycles have been with us for centuries. Governments use debt to finance wars, and after wars are over, the private sector tends to recover, leading to more financial borrowing. Ultimately, too much borrowing, leading to a glut of debt. These in turn require government bailouts.
Not only is the process exhausting, it creates economic and political fragility — from stock market crashes and housing crises to the collapse of the debt ceiling and popular revolt against the rich.
We don’t yet know how to get out of a debt-driven growth cycle, but Vague offers ideas on how to contain the most dangerous debt gluts and prioritize different stakeholders when the inevitable defaults strike. The key lesson is that, in many cases, the pace at which debt increases matters as much as the total amount of debt itself. He recommends that policymakers focus on this indicator in both the public and private sectors.
Debt forgiveness should not be considered from a moral point of view, but as a practical economic solution. Vague thinks celebrations in areas like student loans and medical debt are worth celebrating because they encourage spending. Reducing the large trade deficit is another way to address the debt problem, which would support the arguments of those in the United States who want a better balance between consumption and production. That goal has been prioritized by the Trump and Biden White Houses.
Of course, one country’s deficit is another country’s surplus. Just as public and private sector lending is intertwined, so is US and world debt.
rana.foroohar@ft.com