‘Heed history's warnings on government debt’
Eighteenth-century thinkers foresaw today’s government debt crisis, says Edward Chancellor
Government debt markets have been around since the city-state of Venice issued its first bonds in 1171, but public debt only became tradable in the English-speaking world six centuries later.
Contemporaries held conflicting views about the development. Several leading members of the Scottish Enlightenment were downbeat. As government debt across the developed world escalates, their concerns are proving timely.
In his book, A Fabulous Debt: The Epic Story of How Bonds Built the Modern World, Financial Times journalist Robin Wigglesworth explains how Britain's geopolitical ascendancy was inexorably linked to its public finances, and in particular its ability to issue vast quantities of low-cost debt.
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Thomas Mortimer, an 18th-century financial writer, described the nation's bond market as “the standing miracle in policies, which at once astonishes and overawes the state of Europe”.
Not everyone was sanguine. In his 1752 essay Of Public Credit, the Scottish philosopher David Hume fretted about Britain's newfound tendency to “mortgage the public revenues, and to trust that posterity will pay off the incumbrances contracted by our ancestors”.
Access to the bond market, said Hume, allowed politicians to behave extravagantly without having immediately to raise taxes. “The practice, therefore, of contracting debt will almost infallibly be abused, in every government.”
Adam Smith, the economist who wrote The Wealth of Nations, claimed the issuance of long-dated public debt “has gradually enfeebled every state that has adopted it… When national debts have once accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid.”
Another Scottish contemporary, Adam Ferguson, opined that a permanent and unproductive national debt was “to be reckoned among the causes of national ruin”. In the decades after these warnings were issued, Britain's national debt kept expanding. No crisis appeared, however, and the country's prosperity grew apace.
Looking on the bright side
In his History of England (1848), Thomas Babington Macaulay mocked the debt doomsayers. He hailed Britain's “fabulous debt” as “the greatest prodigy that ever perplexed… statesmen and philosophers.
At every stage in the growth of that debt, it was seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt went on growing; and still bankruptcy and ruin were as remote as ever.”
The error of the pessimists, said Macaulay, lay in their comparing national debt to that of an individual borrower. Since most of Britain's public debt was held by its countrymen, the nation was in effect borrowing from itself.
They also ignored that economic growth rendered the debt sustainable: “They greatly overrated the pressure of the burden; they greatly underrated the strength by which the burden was to be borne.”
The conditions that created a stable bond market in Macaulay's day have vanished, however. Economic growth across much of the developed world has faltered. Excessive borrowing and spending by governments is partly responsible.
Bloated government spending is to blame for the collapse in productivity growth, according to Swedish economists Andreas Bergh and Magnus Henrekson. Hume expected that excessive debt would lead to debilitating taxes.
Government debt levels have risen inexorably since the financial crisis. Worldwide public debt has reached 94% of GDP, according to the International Monetary Fund. US federal debt is around 114% of GDP, reckons Fitch Ratings.
Economists Carmen Reinhart and Kenneth Rogoff concluded that when government debt breaches the 90% threshold, economic growth falters.
Hume would have agreed: “We have always found,” he wrote, “where a government has mortgaged all its revenues, that it necessarily sinks into a state of languor, inactivity and impotence.”
He cautioned that overseas investors owning big portions of a country's debt “render the public, in a manner, tributary to them”.
A large share of the national debt issued by the US, Britain and France is held abroad. For instance, a third of Washington's $40 trillion in borrowing comes from beyond its shores.
Whereas Britain in the 19th century was the world's top creditor, the US today is the world's largest debtor.
The Bank for International Settlements notes that rising geopolitical tensions could disrupt capital flows, threatening nations with large current account deficits.
After interest rates shot up four years ago, government borrowing costs soared. This wasn't a problem in Macaulay's Britain, where public debt was mostly financed with fixed-interest perpetual bonds.
By contrast, US public debt has a relatively short maturity profile, rendering it more sensitive to changes in short-term interest rates. Rising interest costs on a large stockpile of debt strain government finances.
The historian Niall Ferguson says the decline of a political superpower becomes evident when it spends more on servicing debt than on defence. The US breached this threshold two years ago.
Hume envisaged a day when an overburdened government would stop paying interest on its debt.
Since governments nowadays print the money in which their debt is denominated, an option not available in 18th-century Britain, formal default is unnecessary.
Instead, bondholders can be short-changed through inflation, financial repression and the management of long-term interest rates.
“The natural death of public credit,” said Hume, is inevitable when “overbalanced by a great debt”. The Scottish philosopher's timing was disastrous, but his principles remain sound.
A longer version of this article was first published on Reuters Breakingviews.
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