The EconomistMarch 28th 2020 Finance & economics 75T
his is notime to fret about government debt. While cases of
covid-19 soar and economic activity grinds to a halt, govern-
ments are right to throw all the resources they can at efforts to lim-
it the pandemic’s human and economic costs. This urgency not-
withstanding, the crisis will push sovereign-debt burdens into
new territory. Over the past century, major global crises have often
led both to large-scale borrowing by governments and to
changes—often radical—in the way they handle their creditors.
The battle against covid-19 is unlikely to prove an exception. Eco-
nomic rescue plans now being drawn up are likely to outstrip
those employed during the financial crisis; America’s may be
worth around 10% of gdp. The blow to output and to tax revenues
could also be larger. At least a few economies are likely to find
themselves with debt loads well in excess of 150% of gdp.
The history of government borrowing over the past hundred
years or so can be divided into three periods. Between the start of
the first world war and that of the second, conflict, rebuilding and
the Great Depression all placed enormous demands on govern-
ment balance-sheets. During this tumultuous period, govern-
ments were often at the mercy of market sentiment. Britain sought
to maintain market confidence by reducing debt—which rose to
140% of gdpimmediately after the first world war—through pain-
ful austerity. The government ran a primary-budget surplus (ie,
net of interest expenses) of 7% of gdp throughout the 1920s.
The results were disastrous. Austerity undercut economic
growth: output in 1928 remained below that in 1918. As a conse-
quence, debt continued to rise, reaching 170% of gdpin 1930. Re-
marking on the bitter experience, John Maynard Keynes noted that
“assuredly it does not pay to be good.” Other economies, forced
into more desperate measures, fared even worse. Germany, weak-
ened by war and unable to meet its debt obligations, sank into hy-
perinflation. The destruction of the currency’s value reduced its
debt burden as a share of gdpby a huge 129 percentage points, albe-
it at enormous social and economic cost. Default was also com-
mon. In 1933 countries making up nearly half of global gdpwere in
some form of default or debt restructuring.
During and after the second world war, the governments of ad-
vanced economies tried a different approach. After the trauma of
the previous 30 years, austerity was no longer a politically tenable
means of dealing with the debts built up over the period. Some
countries defaulted or experienced post-war hyperinflations. Oth-
er governments turned to financial repression—ie, forcing cred-
itors to lend to them on unattractive terms. Many of the tools of re-
pression had been deployed during the war to pay for the conflict.
In America, for instance, the Federal Reserve bought Treasuries to
prevent yields from rising above a set level. The government also
capped the interest rates banks could charge borrowers or pay de-
positors, and restricted bank lending. Capital controls prevented
savers from seeking better returns abroad.
The effect was to force domestic institutions and households to
lend to the government at below-market rates. As wartime price
controls were relaxed, inflation rose to relatively modest levels
and the rate of interest on government debt, adjusted for inflation,
turned negative, and remained so for much of the ensuing de-
cades. According to work by Carmen Reinhart of Harvard Univer-
sity and Belen Sbrancia of the imf, real interest rates across ad-
vanced economies were negative roughly half the time between
1945 and 1980. The British government paid an average real interest
rate over the period of just -1.7%; the French, -6.6%. The effect was
powerful. Between 1946 and 1961 America’s debt-to-gdp ratio
dropped by 68 percentage points. In the 1970s debt to gdpacross all
advanced economies sank to a low of 25%.
A third era began in the 1970s. Governments of advanced econo-
mies loosened their grip over capital flows and financial systems,
placing themselves once more at the mercy of global capital mar-
kets. Though bond markets occasionally pushed politicians
around in the 1980s and 1990s, they slowly lost their power to instil
fear. Global financial integration has coincided with a rise in de-
sired saving relative to investment, and a hearty appetite for the
safety provided by the bonds of rich countries with stable curren-
cies. Borrowing costs have fallen steadily, even as debt loads have
grown. The global financial crisis only reinforced this trend. Pub-
lic debt in rich countries rose from 59% of gdp in 2007 to 91% in- Yet rich-world governments have been able to borrow at near-
zero or negative rates over the past decade.
Money printer go brrr
Covid-19 means there is more red ink to come. A new era of sover-
eign-debt management could be about to begin. What this period
may bring is not yet clear. The post-pandemic debt regime might
resemble that of the immediate post-war era. The trials of this cri-
sis could inspire a new wave of investment in technology and in-
frastructure, leading to fierce competition for available savings
and higher government-borrowing costs. Repression would allow
governments to manage the surge, especially if barriers to goods
and capital go up in the aftermath of national lockdowns.
Alternatively, growth may prove difficult to restart as the pan-
demic ebbs. Central banks, in an effort to provide relief to troubled
economies, are already buying up large quantities of government
debt. The Fed is purchasing unlimited amounts of Treasuries; the
European Central Bank recently announced a €750bn ($809bn)
bond-buying scheme. A weak recovery could push central banks to
finance large fiscal deficits with freshly printed cash on an ongo-
ing basis. The experience of Japan, once considered an economic
oddity, will be repeated more widely. Money-financed borrowing
on that scale, with no inflationary consequences, would turn pop-
ular ideas about the limits to debt on their head. It would not be the
first time a crisis rewrites the rule book. 7Free exchange How to pay for the pandemic
The world is entering a new era of sovereign-debt management