Growth and inflation have in the past been the main routes to reducing debt
but in Europe growth was high when debt was last low and even inflation is
not the tool it once was for relatively prudent countries. For example,
last had an annual budget surplus in 1974 and
every year from 1975 to 2013, the national debt grew. It was at 22% of GDP
(gross domestic product) in 1975; 64% in 2006; 82% in 2010; 86% in 2011; the IMF
expects the ratio to be 93% in 2013.
Adam Smith, the
Scottish philosopher-economist wrote in The
Wealth of Nations that was
published in 1776: "“When
national debts have once been accumulated to a certain degree, there is scarce,
I believe, a single instance of their having been fairly and completely paid.
The liberation of the public revenue, if it has been brought about at all, has
always been brought about by a bankruptcy; sometimes by an avowed one, but
always by a real one, though frequently by a pretended payment. The raising of
the denomination of the coin has been the most usual expedient by which a real
public bankruptcy has been disguised under the appearance of a pretended
Brittan, the venerable Financial Times economics commentator, wrote in 2009
that the UK debt ratio has historically been much higher than in modern times -
- more than 200% after the Napoleonic wars and again after the World War 2 - - "without
the disasters predicted by prophets of doom."
A study from
the IMF in 2010, the year of the publication of the infamous Reinhart-Rogoff
debt paper, said that whether a major country’s debt is sustainable is primarily
a function of the interest rate paid on it, not the size of the debt per se.
Italy's current debt servicing cost is half the early 1990s level despite its
127% of GDP public debt level.
Economists at Morgan Stanley,
said in 2010 that World War 2 left the US with a large debt overhang. In 1946,
US public debt was 108.6% of GDP. Nearly 60 years later, in 2003, public debt to
GDP was just 36%. Within two generations, debt had been reduced by over 70pp of
GDP. This corresponds to an average decrease of debt/GDP by
1.2% every year. How was this achieved? They say that remarkably, between 1946
and 2003 the federal budget was, on average, in deficit, to the tune of 1.6% of
GDP as the surplus in the primary balance (0.3% of GDP on average) was not
enough to cover interest payments on the debt (1.9% of GDP on average).
MS numbers show that while
real GDP growth reduced debt/GDP by 1.3% on average, the
effect of inflation on the debt ratio was larger: 1.6%, on average,
between 1946 and 2003. (In relative terms, 56% of the total Nominal Growth
Effect on the debt ratio is due to inflation, with the remainder being due to
real GDP growth.)
The largest contribution
of inflation to debt reduction came in the decade immediately after World War 2
(1946-1955). Despite a primary surplus (before interest payments on the national
debt) of 1.2% of GDP, overall the budget was in deficit by 0.3% of GDP on
average. Yet, the debt was reduced by 4.9% of GDP a year, through a nominal
growth effect of 5.2% annually, as nominal GDP growth averaged 6.5% over the
period. This very large nominal growth effect is mainly due to a substantial
inflation effect - - inflation averaged 4.2% over the period - - which reduced
debt to GDP by 3.7% every year, and to a much lesser extent to real GDP growth,
which on average contributed 1.5% of GDP to debt reduction.
Can inflation work the magic
The big jump in inflation in
the 1970s caught bond investors on the hop and sovereign debt maturities were
generally over a long maturity profile.
According to the Treasury Department, almost three-quarters of 2011 US debt
had maturities within five years and the FT
has calculated that if the UK had
the same debt maturity as the US, it would cost an additional £9.2bn per
year in interest costs.
inflation as a tool, which would be a risky move in itself, would not leave the
bond investor unarmed this time; they would strike back in modern times as
sovereigns need to go to the lending well much more frequently.
US v Eurozone
The US deficit is falling because of rising cyclical revenues and spending
cuts. Pentagon contracts tumbled 52% in April from a month earlier as
across-the-board federal budget cuts took hold -- it's not
called austerity but payroll tax rises for all workers and personal tax
rises for rich people are also taking effect.
The US government ran a $1.089tn budget deficit in the fiscal year that
ended Sept. 30, a smaller gap than the year before but still stubbornly high and
likely to fuel further debate over tax and spending policies.
The deficit was roughly 7.0% of the country's 2012
GDP. That is the lowest share since President Barack Obama took office, but
still one of the largest since 1945.
The deficit peaked in 2009 at $1.413tn, or 10.1% of GDP.
Analysts at Goldman Sachs estimate that in the first quarter of 2013 the deficit
was running at a cyclically adjusted level of just 4.5%.
It's too early to be definitive that the US can avoid a new normal of
long-term lower growth than in postwar decades, while Eurozone stagnation is
more certain. Real US GDP rose an average
of 3.4% per year from 1960 through 2007.
The Economist says real growth rate in six European countries (Spain, UK, Netherlands, France,
Germany, Italy) has been slower in each successive decade (on average) since the
1960s; the drop between the 1960s and the noughties was a staggering 54
percentage points. The US saw fairly steady growth from the 1970s to the
1990s before dropping off this century - -
see chart above.
According to Eurostat data released in April, the Eurozone’s (17 countries)
fiscal deficit rate and debt rate as a percentage of GDP (gross domestic
product) in 2012 averaged 3.7% and 90.6%, respectively. The US deficit was 7.0%
of 2012 GDP and the debt GDP ratio was 106%.
Gillian Tett of the FT reports: “Late last month, the International
Monetary Fund published its World Economic Outlook, in which a tiny chart (on
page 5) shows that American household debt, as a proportion of income, declined
from 130% in 2007 to 105% at the end of 2012. In the same
period, Eurozone household debt has risen from 100% to almost 110%. Historically, Europeans always had a lower debt ratio than Americans, but
those two lines have now crossed. It is a stark contrast to the pattern in 2000,
say, when the ratio was only 80% in the Eurozone — and 90% in
In the Fortune Global 500 of 2011, there were 160 European firms and 133
American; Nestlé of Switzerland was the world's most profitable company.
has over 1,300 so-called Hidden Champions - - medium-sized
mainly family-owned firms that account for 25% of exports and are defined as
world leaders in their niche sectors. The number is a multiple of every other
country's total including US, China and Japan. Austria and Switzerland also have
According to The New York Times, the share of American adults with jobs has
barely changed since 2010, hovering between 58.2% and 58.7%. This
employment-to-population ratio stood at 58.6% in April 2013. That is about four
percentage points lower than the employment rate before the recession, a
difference of roughly 10m jobs. According to the Labor Department, workers 25 to
34 years old are the only age group with lower average wages in early 2013 than
Eurozone unemployment was at a rate of 12.1% in March; the US official rate
was 7.5%. Gavyn Davies in the FT says today on the US rate: "...large numbers of
people have left the labour force altogether as the recession has dragged on,
and this probably means that the official unemployment rate is no longer acting
as a consistent measuring rod for the amount of slack in the labour market."
The EZ rate may also be understated.
The broad measure of US employment (U-6) including discouraged workers and
involuntary part-timers was 13.9% in April - - one of the highest levels
imbalance between labour and capital has worsened during the recession.
The richest 1%, the world’s 1,426 billionaires, are likely stockholders in the Dow’s latest
rally that’s more than doubled from the 6,547 bottom in March 2009 to last week's
record over 15,000. Meanwhile GDP has been hurting the other 99%, as wages
stagnated for this generation.
Michael Greenstone and Adam Looney of the Brookings Institution said in 2012:
"When we consider all working-age men, including those who are not working, the
real earnings of the median male have actually declined by 19% since 1970. This
means that the median man in 2010 earned as much as the median man did in 1964 —
nearly a half century ago. Men with less education face an even bleaker picture;
earnings for the median man with a high school diploma and no further schooling
fell by 41% from 1970 to 2010."
The EZ faces a long period of low growth; the US picture is murkier.
The pre-US recession employment creation rate was down from the previous two
decades. The declining job creation from employer business startups (firms with
reflects a declining firm startup rate. The startup rate of firms has
declined from as high as 12% to 13% (as a percentage of all firms) in the 1980s
to 7% or 8% in recent years. There has been no discernible trend in the average
size of a new firm.
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