Government bailouts look set to explode already stretched deficits. While necessary in the short-term, what may be the longer-term consequences?
- Fiscal bailouts are stretching government finances to bursting point
- Debt to GDP ratios are set to expand by 20-30%
- There are only three ways out: inflation, growth or default
Are we going bust? That’s the question asked by M&G’s Jim Leaviss in his ‘Uncle Jim’s World of Bonds’ podcast. It is pertinent question for our times as governments launch vast bailouts to deal with the economic fallout from the Covid-19 outbreak. These bailouts are welcome to shore up the economy, many will be wondering about the long-term consequences.
The numbers involved are eye-popping. Leaviss estimates that the US may have to issue as much as $3 trillion in the rest of 2020 alone. Just a few years ago, $1 trillion was considered a line in the sand on annual borrowing. Even fiscally prudent Germany has said it will spend 4.5% of GDP this year. Rishi Sunak may have got the glory in the UK, but the purse strings have loosened across the globe.
A ‘normal’ deficit to GDP ratio is around 2%. The Maastrict criteria had a limit of 3% (though this was famously fudged in some cases). Today it is more like 14% for the US and 8% for the Eurozone. Similarly, debt to GDP ratios are also high. France and Spain are running at around 100%, Italy at 135% and the US at 79%.
Leaviss says that the bailouts will see this ratio explode. Debt goes up and GDP falls, so both sides of the equation are hit. On current estimates, France and Spain will now run at 120%, Italy at 160% and the US will go through 100%. These are levels last seen at the end of the second world war.
This is alarming, but some economists are more sanguine, suggesting that as long as an economy grows at a higher rate than the interest on government debt, borrowing is reduced over time. Equally, interest rates are low and debt servicing is easy, no matter how much the doomsters predict a day of reckoning.
That said, there are only three ways out of this debt burden: growth, inflation or default. Of these, growth is the best option: there is a chance of a V-shaped recovery, but higher debt may make growth more difficult to achieve in the longer-term. Inflation would work, but then investors should expect higher borrowing costs in the long term. all have negative consequences. The worst would be default. This isn’t a significant risk for major economies such as the UK, US or Japan who could just print money to pay it back but remains a risk elsewhere.
This is uncharted territory. There is some solace to be taken in the fact that all the major economies of the world are in the same boat. But we are in the middle of a huge financial experiment and the repercussions are as yet unclear.
