How Much Government Debt is Too Much?

  1. The government can ultimately “print money” to pay its own debt. Although this is not officially allowed in most industrialized countries, that is what is happening in reality: central banks are buying government debt by the truck loads (and this is equivalent to printing money to pay for debt). The government then owes the debt held by the central bank to… the central bank… and the central bank pays the immense majority of its profits to… the government! So, debt held by the central bank is the government owing money to itself: it doesn’t really “count”! That is why the simplistic measure of “total debt / GDP” is misleading, because it counts the debt held by the central bank and it should not. A much better measure of “debt pressure” would be “debt outside the central bank / GDP”.
  2. The government can ultimately increase taxes to pay it’s debt obligations, which a household can’t do. This is politically explosive, but if push comes to shove, it is possible. Countries with already-high tax burdens (France, Germany, Italy) can’t afford this luxury as much as those who currently have low tax pressure in general (USA, Australia, Switzerland), while those with mid-way tax pressure also have mid-way space to cover the burden of debt with tax increases (Canada, UK, Japan).
  3. The government can push back forever the actual payment, because the government can “re-borrow” (debt rollover) when payments are due and does not have the money. This is not an option for individuals, who must ultimately pay debts at one point.
  1. Tax more.
  2. Cut government spending in a major way.
  3. Print money to pay the debt.
  1. Interest rates.
  2. Inflation.
  3. The value of the currency.
  1. Inflation: steadily rising above 3% and 4% would become risky.
  2. The 10-year government bond yield: convincing increases could signal some problems ahead.
  3. The value of the currency: a steady and prolonged drop would signal falling asset demand from the rest of the world, and that could also be a sign of things to come.
Walking towards a new climbing area to explore new crags.

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Pascal Bedard

Pascal Bedard

Sharing thoughts on economics, finance, business, trading, and life lessons. Founder of www.PascalBedard.com