Debt panic
A kindly message to the new government. Debt panic is a danger to us all. Strangling the economy to “balance the books” is as economically literate as burning down a factory to save on heating bills.
Appropriately deployed, for example into capital expenditure for infrastructure, but also into key services such as health, education and skills, transport, social security and defence, government debt plays a major role in ensuring we can fund our needs, raise our ability to generate wealth-creating production and stay safe.
The large quantities of pounds the government often spends into the economy in excess of the numbers of pounds it removes from the economy in taxes, counted annually, is referred to as the government budget deficit.
The sum of those deficits over the years to date adds up to what is commonly called the government debt. Its nature has changed over the years, not least as the monetary system has changed. We will come back to that later.
A Great British debt tradition
We have always had government debt.
Over the last three centuries there have been extraordinary technological changes which, along with regrettably exploitative practices, have generated vast – if unequally distributed – wealth. There have also been major national crises, notably wars and economic heart attacks.
Without government debt the UK wouldn’t have had the money to prosper or even survive.
Measured in constant 2011 US dollars (comparable figures across time, correcting for inflation and exchange rate movements) in 1880 UK government debt was $120 billion, having been a tenth of that in 1730.
By the early twentieth century it was around $100 billion, increasing to about $600 billion in the 1930s.
In 1947 it was over $1,300 billion, by the late 1960s $500 billion, and similar in the 1970s to 1990s.
By 2000 it was approaching $750 billion, 2010 more than double that, and in 2020 $2,800 billion.
The debt has never been zero, or anywhere close. It was never “paid back”: overall it rose dramatically. At different times it has been at greatly different levels, whether in pounds or as a percentage of UK economic output.
UK economic output, in the form of Gross Domestic Product (the annual sum of government expenditure, consumption, investment and net exports) has multiplied by a factor of 125 over the period since 1730 – again, in constant 2011 US dollars. Per capita (dividing the GDP figure by the population size) it is 15 times higher than in 1730.
AI: artificial indebtedness
When the UK followed the Gold Standard, the amount the government could spend depended on the amount of gold it held, as every pound had to be redeemable by the Bank of England for a fixed weight of gold.
By those rules, any (positive) difference between what the government spent and what it took in taxes had to be covered by borrowing gold, or the guaranteed promise of gold, from those willing to lend it to the government. Since the government couldn’t create gold at will, this was a real debt which could only be honoured by collecting enough gold (or promise of it) to pay it back at some time in the future, in the meantime paying interest on the outstanding loan.
In 1971 all that dramatically changed.
The post war system of fixed exchange rates, and currencies ultimately backed by gold, was abolished.
Countries such as the UK, the USA and other developed economies agreed to a new set of rules. National governments would now, with democratic approval according to their constitutional arrangements, create at will, from nothing, as much (or as little) of their national currency as they saw fit at any given time. There would be no fixed limit. Nor would exchange rates between currencies be fixed: they would “float”, varying day by day, hour by hour. Free movement of capital across international frontiers, involving those currencies, observing the new rules, became the norm.
Inflation: the limiter
The limit on governments putting more pounds (in the UK’s case) into the economy than they took out in taxes was no longer whether they could “borrow” to cover the gap: they could create as many pounds as they liked. It was inflation: if the UK’s economy had spare, unused productive capacity, or could get hold of some, pumping in that extra cash would tend to stimulate economic growth; if there wasn’t that spare capacity, excessive inflation would be likely to result.
Since 1971, the UK government (as others) has continued to observe the convention of selling Treasury bonds (“gilts”, in the UK) to cover the government budget deficit. But that’s all denominated in pounds which the government can (and in huge quantities routinely does) create at will.
Welcome to the strange world of artificial indebtedness: whatever the reasons may be these days for still selling gilts and thereby running up “government debt”, and paying interest on it, it isn’t because the UK government needs to borrow pounds.
As for the real limiting force on government budget deficits (inflation), it’s easy to see why leaving a domestic market for goods, services, people (labour) and capital with a $19 trillion GDP and a population over 400 million, and retrenching to one of $3 trillion and 70 million people, is a recipe for both inflationary pressure and depression of economic activity.
Fortunately, no country would ever do anything so silly.
A fool’s errand
There is no “correct” level of UK government debt, either as a percentage of GDP or as a number of pounds.
Panicking about government debt is a fools errand, and a danger to our security and prosperity.
We should leave that to fools.
