The rise and rise of government debt

The rise and rise of government debt

UK government debt has reached £2.8tn, equivalent to 100% of GDP and up from 36% 20 years ago. The borrowing needed to counter the effects of the financial crisis of 2008–09, the pandemic and the energy crisis has led to a near tripling of UK public sector indebtedness. The last time public sector debt was at 100% of GDP was in the early 1960s when the UK was repaying debts incurred during the second world war.

• The 100% figure is an underestimate because it fails to capture the scale of future liabilities facing the government. If the cost of paying public sector pensions were included, UK public sector debt would rise from 100% to 150% of GDP. Add in the cost of welfare and health and the figure would rise far further.

• The Office for Budget Responsibility recently published long-term forecasts for public debt based on current policies. As the population ages and liabilities crystallise in the form of increased spending on welfare and health the OBR forecasts that UK public debt will reach 274% of GDP by 2074.

• The public finances of many other rich, ageing countries are on a similarly unsustainable path.

• Despite good growth, the US is on course to borrow the equivalent of 7% of GDP, or $2.0tn, this year. Such levels of borrowing are almost unknown outside recessions or wartime. US public sector debt has risen from 36% of GDP in 2004 to almost 100% today. By 2054 the independent Congressional Budget Office (CBO) forecasts that it will stand at 166% of GDP.  

• A modelling exercise run by academics at the University of Pennsylvania (UPenn) last year suggested that the US has no more than a couple of decades to turn things around: “financial markets cannot sustain more than the next 20 years of accumulated deficits projected under current US fiscal policy… financial markets are… effectively betting that future fiscal policy will provide substantial corrective measures ahead of time”.

• “Substantial corrective measures” means some combination of cuts to public expenditure and increases in taxes to arrest the rise in debt. Without such action the US government is, according to the UPenn team, likely to “default explicitly or implicitly” within 20 years (an implicit default meaning that the government runs high levels of inflation to reduce the real value of debt).

• The painless way out of this debt trap is through faster growth. Higher growth means increased tax revenues, lower welfare spending and less borrowing. No wonder Britain’s new government has put so much weight on raising the UK’s lacklustre growth rate. Yet if this were straightforward, the UK would not have a growth or a debt problem – nor would the US. Every government wants faster long-term growth. Few achieve it. 

• While all governments pay lip service to sound public finances, in the West it hardly seems to be a pressing political priority. Low interest rates and the seemingly bottomless appetite of financial markets for government debt may have anaesthetised politicians and voters to the risks. It is striking that debt reduction is not a major issue in the current US election campaign nor features as a prominent concern for voters.

• It was not always so. Public debt, though far lower than today, was a major issue in US politics in the early 1990s and featured prominently in the 1992 US election. Having won that election Bill Clinton raised taxes and cut spending, which, in turn, helped turn the public finances from deficit to surplus. US public sector debt fell from 47% of GDP in 1993 to 31% by 2001 helped, it should be said, by strong growth and the post-cold war reduction in defence spending.

• The US and UK also achieved massive feats of debt reduction after the second world war. In the UK debt peaked at 252% of GDP in 1946. Debt reduction then was achieved through strong economic growth and artificially low (in fact negative) real interest rates. Governments also used ‘financial repression’, forcing banks to hold public debt, implementing capital controls and fixing exchange rates.

• Avoiding an ever-rising burden of debt today requires long-term planning, beyond the lifetime of any government or parliament. An example was the decision taken by the then Conservative government in 1995 to raise the UK state pension age in stages from 2010. Starting at 60 for women and 65 for men the UK retirement age will eventually reach 67 in 2027. The changes were announced 15 years before they started to be implemented, giving people time to plan well in advance and adjust their thinking on savings and retirement accordingly. 

• Where does this all leave us today? Levels of public debt in many western countries are running at multi-decade highs. Meanwhile, the cost of servicing that debt has risen and the rate of GDP growth has fallen. Ageing populations and the rising cost of welfare and health will exert powerful upward pressure on government spending over coming decades.

• The IMF thinks America’s borrowing is so vast that it endangers global financial stability. The chairman of the Federal Reserve, Jay Powell, says US debt is on an unsustainable path. The long-term outlook in the UK and other western countries, including France and Italy is equally challenging. Politicians and voters need to start worrying about public debt.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 1.1% at 8,321 as stock markets around the world rose following the announcement of China’s monetary and fiscal stimulus package.

Economics

• China unveiled a substantial package of fiscal and monetary stimulus including a cut to its benchmark interest rate and a $114bn fund to support financial markets. Chinese stock markets recorded their best week since 2008
• Early estimates from surveys of purchasing managers indicated business activity increased in September across the US and UK, but at a slowing rate compared with August
• Euro area business activity fell in September for the first time in seven months, driven by falls in the manufacturing sector
• The OECD upgraded its forecast of UK growth to 1.1% throughout 2024 while maintaining forecasts for the US and euro area at 2.6% and 0.7%, respectively
• The US consumption expenditure price index, the Fed’s preferred inflation measure, came in below expectations at 2.2%, bolstering hopes of further US interest rate reductions
• Congress approved a bill to fund US federal agencies until December, avoiding a government shutdown in the run-up to the election
• The median UK household disposable income fell to £34,500 in 2022–23, the lowest since 2018–19, according to official figures
• UK car production fell 8.4% in August compared with the same month last year, continuing the trend of declining output as factories restructure to produce newer, primarily electric, models
• UK chancellor Rachel Reeves said that “there will be no return to austerity” in the upcoming budget
• The UK government is reportedly reconsidering plans for tougher tax rules on non-domiciled individuals amid concerns they may not raise as much revenue as expected
• German business sentiment deteriorated for the fourth consecutive month in September, according to an influential survey run by the Ifo Institute
• The spread between France and Germany’s ten-year bond yields reached a seven-week high amid concerns over France’s growing deficit
• A number of policymakers at the European Central Bank are planning to push for a cut to interest rates next month following a run of weaker than expected economic data, Reuters reports
• The Swiss and Swedish central banks reduced interest rates again
• Saudi Arabia is considering increasing oil production despite relatively low crude prices as it is unwilling to continue ceding market share, the FT reports
• Argentina’s poverty rate rose to 53% in the first half of 2024, the highest in 20 years, amid large public spending cuts by president Javier Milei
• The 140mph category four hurricane “Helene” that swept through Florida was one of the strongest recorded in the US history

Business

• Italian bank Unicredit has purchased an additional 11.5% stake in German lender Commerzbank sparking concerns in the German government over the possibility of a takeover bid
• UK property website Rightmove rejected a third takeover bid from Australian REA Group that valued the company at £6.1bn
• The US Department of Justice filed a lawsuit against payment services company Visa accusing it of anticompetitive practices
• The credit rating of the UK’s largest water supplier, Thames Water, was cut further into junk territory by credit rating agencies
• Surveys undertaken by dairy co-operative Arla found that labour shortages in the dairy sector and subsequent wage inflation are squeezing production in the sector
• UK nurses rejected a 5.5% pay deal for 2024–25 from the government sparking concerns of further strike action
• Former CEO of Alameda Research, Caroline Ellison, was sentenced to 24 months in prison for her role in the collapse of crypto exchange FTX

Global and political developments

• Over the weekend Israel widened its offensive against Iranian-backed militants by bombing Houthi rebels in Yemen
• Hezbollah leader Hassan Nasrallah was killed in an Israeli airstrike 
• Israel’s military chief told Israeli troops to prepare for a potential ground offensive in Lebanon
• The UK government’s new energy company, GB Energy, will be based in Aberdeen
• UK energy secretary Ed Miliband announced plans to increase energy efficiency across private rental properties and social housing in England by 2030
• The FBI is investigating whether a US venture capital fund that took Chinese money passed sensitive commercial information back to China, the FT reports
• Belgium’s energy minister, Tinne Van der Straeten, has called for the European Union to renew efforts to ban Russian fuel amid concerns of rising liquified natural gas imports from Russia
• Italy’s minister for industry Adolfo Urso said that European car manufacturers are in a “grave crisis” because of the EU’s ban on the sale of combustion engine cars after 2035
• One of China’s top economists, Zhu Hengpeng, has gone missing after allegedly privately criticising Chinese president Xi Jinping on messaging app WeChat, The Wall Street Journal reports
• The Social Democrats, led by Germany’s chancellor Olaf Scholz, won 31% of the vote in Brandenburg’s state elections, followed by the right-wing Alternative for Deutschland party
• Austria’s far-right Freedom Party has won a historic electoral victory

And finally… a plane flying from Oslo to Malaga had to make an unscheduled landing after a live mouse was discovered in a passenger’s in-flight meal… bubble and squeak