How will we reimburse the debts that States have accumulated? And if the amount of these debts is not a problem, why have we not increased it to a much higher level and much sooner?
The answers to these questions, which everyone is asking, determine our future to a very large extent. The Bank of Japan (BoJ), the European Central Bank (ECB) and the Board of Governors of the Federal Reserve System (the Fed) are expected to give new answers to these questions this week at their monthly meetings. And if European countries deviate from a common response, the European project will be condemned.
At the current rate, the United States’ level of debt in 1946 (106%) of its gross domestic product (GDP) could be exceeded in 2023. Japan’s debt already exceeds 200% of its GDP. Italy’s debt should rise from 135% to 155% of GDP before the end of 2020. France’s debt is expected to increase by 17 points to 115% of GDP by the end of 2020. On average, the debt of the OECD members will exceed 120% of GDP in 2021. The Eurozone’s debt should, at best, reach 112% of GDP in 2022, against 84% of GDP at the end of 2019. Global debt, both public and private, is approaching 300% of global GDP.
Should we be worried about it? Not necessarily.
First, we must question the criterion for evaluating public debt: comparing it to GDP is as absurd as comparing the debt of a town hall to the total income of all the inhabitants of the municipality; whereas, similar to the methodology for a household, we must compare it to the budget of the municipality, and seek to know whether the indebted sum was used for investment or to pay current expenses; take into account reimbursement capacity and the identity of the borrowers.
Then, we must ask ourselves how to clear the debt. History teaches us that there are four ways: growth, repayment by borrowers, cancellation by lenders, or war.
1. Growth, even when accompanied by modest inflation, is the best solution: after 1945, it largely wiped out the war debt, both in the United States and in Europe.
2. Repayment, whether voluntary or forced, by borrowers (i.e., taxpayers) requires increasing taxes and decreasing public spending, which is called “austerity.” This is obviously politically unacceptable (how can we make households pay for what has been widely distributed to businesses?), and economically absurd, because it would destroy any prospect of growth and weaken the economy of life.
3. Large-scale debt cancellation involves forgiving public debts. It is regularly practiced in emerging countries (and even recently for African countries) but is very difficult to imagine in developed countries. Recently, the President of the European Central Bank even dismissed this solution, describing it as “totally unthinkable.” Moreover, when the debt is, as in Japan and Europe, held mostly by nationals, debt-cancellation would only impoverish the country. Finally, debt forgiveness programs based on inflation by lenders is also an unlikely scenario today, and will remain so for a long time, unless a serious food crisis triggers it.
4. That leaves us with either a war or a pandemic to make tax increases acceptable. But we know that is intolerable, of course.
And since neither of these solutions are popular, political leaders are trying by all means to avoid deciding. And for that, they have shifted the responsibility to the central banks: when the time comes and the private debts are bought by the States, they will sell them back to their central bank, thus organizing a more or less direct financing of households, companies and public spending, through the money printer. Some central banks are already buying corporate bonds, real estate debts and soon local government loans.
This is already reflected in the balance sheets of the three main central banks (Japan, US, and Europe), which have increased from USD 3.4 billion in 2017 to USD 14.6 billion in 2019, and may rise to more than 20 billion before the end of the year. The balance sheet of the Fed alone will triple in 2020. The ECB now holds 20% of the public debts of the euro zone, and soon it will be 25%. And even more than 30% of the German public debt.
When politicians give up all courage and transfer their responsibilities to their central banks, which, in a very real sense, means to the money printer, democracy is threatened.
Many believe that this delegation of power to an abstract entity is all the more possible because in theory, a central bank will never go bankrupt; it can even maintain its activity with negative equity capital, as the Central Bank of Chile did for several years.
The result of all of this is that political leaders, whoever they may be, will do their utmost to put the ultimate burden of debt on central banks.
Again, this idea relies, however, on the notion that central banks will undoubtedly continue to exist. This will only be the case for the ECB if the European Union becomes a political, democratic, stable and predictable entity. Until then, European public debt remains an extremely risky political gamble.