How on earth are we going to get rid of all of this debt?

Philip Hammond © Getty Images
Don’t expect the chancellor to tackle our debt pile head-on

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I’m writing a new book at the moment, about everyone’s favourite subject – taxation.

As part of that, yesterday I was having a look at government debt levels around the world.

Usually, whenever I look at these, my first instinct is to grab everything I own and make a run for it.

And yesterday, I’m sorry to report, was no different.

A reminder that a trillion is actually a pretty big number

The UK’s national debt currently stands at $2.1trn. That’s about 87% of our GDP, which is $2.6trn.

That’s only getting bigger, because the UK government also currently spends more than it takes in taxes – in other words, we run a deficit.

The chancellor, Philip Hammond, shelved the plans of his predecessor, George Osborne, to balance the books until 2025. So that means we’ll probably continue to run a deficit until at least then.

In the US, the national debt stands at some $21.5trn, equivalent to 105% of GDP. The German national debt stands at €2.1trn; the French at €2.3trn; Italian at €2.4trn.

It is worth reminding ourselves just how big a trillion is. It is a million millions. This is a trillion: 1,000,000,000,000. I could have spent a million dollars every day since the day Jesus was born, and I still would not have spent a trillion dollars.

Almost every developed nation in the world has a government debt problem. The EU average is 83% (so much for their rules – it’s meant to be 60%); France and Spain both top 90%; Belgium has cleared 100%; Portugal 120%; and Italy 130%. The crown lies with the Land of the Rising Sun. Total gross Japanese debt as a percentage of GDP stands at more than 230% (this is all according to International Monetary Fund figures).

Yet despite this huge existing debt pile, almost every developed world nation also runs a deficit. Japan has run an annual budget deficit since 1966, France since 1993, and Italy since 1950.

The US ran a trillion dollar deficit last year and Donald Trump doesn’t look like the type to rein in spending.

Budget surpluses are a rarity, so the debt is going to get bigger. The only question – and what a lot of national treasuries must be praying for – is that growth is greater.

The only reason that this hasn’t already spiralled into some sort of crisis is thanks to low interest rates. At present, the cost to the UK of servicing its debt is about 6% of government spending. That’s more than half the education budget, to put that number into some kind of perspective.

In the US it is 7%. If interest rates were “normalised” at around 4%-6%, the cost of servicing all that debt would dramatically increase. There isn’t room in already squeezed budgets.

Yet with rates as low as they are, governments can keep taking on yet more debt, and as we have already seen, that’s just what they are doing. That means the cost of servicing the debt will rise even if rates don’t go up.

The longer this goes on, the more trapped we get in the cycle. More debt will encourage further repression of rates. They won’t be able to afford to put them up. So we will continue to see money being debased by interest rate suppression.

The US, to its credit, does appear to be trying to do something about it and is slowly raising rates. Federal Reserve chief Jerome Powell raised them by another 0.25% yesterday, as was widely expected, in his third quarter-point rise of the year. The fear is that the Fed will continue raising rates and overstep the mark.

But even US rates are still well behind the rate of inflation, as my colleagues Merryn Somerset Webb and John Stepek pointed out in the latest MoneyWeek podcast.

The rest of the world is in lock-down.

Is the future Japanese, or is it a lot messier than that?

I enjoyed listening to an interview yesterday with Dr Bryan Taylor, who collates data for the Global Financial Database and authored a wonderfully titled book this year: Debts, Defaults, Depression and Other Delightful Ditties from the Dismal Science.

Taylor points out that the 20th century produced more and worse inflation “than any other century in history… Every single country in the world suffered.” And his findings point to the most likely result of today’s huge debts.

“Governments inflate when they cannot pay their debts,” he said. They cannot pay their debts today, so debasing their currency (AKA inflating away the debt) is one of their means to deal with the situation (spending cuts and higher taxes being the others).

As we noted above, the only reason this situation has not spiralled out of control yet is low interest rates. However, as Taylor points out, rates at just 5%, were enough to push Sweden into crisis in the 1990s, when its debt-to-GDP ratio was around 70%.

I doubt the UK could even tolerate 3%; we may discover what US tolerance levels are over the next year or so.

There are many people who have foreseen some kind of government debt crisis in the past, yet it has never come. Maybe the world is turning Japanese. Maybe, if we want to see what is most likely to happen, we need to look east.

Yet maybe not. Perhaps we’ve just grown too complacent. The furore about national debt has largely dissipated.The situation has gone on for so long that it has become normalized. The predictions of gloom look misplaced. Many are doubting their own judgement.

Yet our situation is undeniably precarious. As Deutsche Bank’s Jim Reid observes in his latest long-term asset return study (John will have more on this in tomorrow’s Money Morning), “periods with a higher number of shocks and crises coincide with higher levels of debt and higher budget deficits.” And what we are experiencing now is, outside of wartime, unprecedented.

Maybe we will get away with it and turn Japanese (if you want to describe that as “getting away with it”). Maybe the government’s mishandling of Brexit will bring the whole thing to the fore and Brexit will cop the blame (as it currently is for UK house prices).

We shall see.

One thing’s for sure though – Hammond will not spring any solutions when he announces his next budget, on Monday 29 October. All you can expect is a little added here and a little taken away there. Business as usual. Head-on reform? Forget it

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