During last week's weekly market insights webinar, John and I continued our conversation on debt and inflation. Of course, we are no stranger to these themes on our calls — but they're becoming more timely than ever with the media hype around inflation. So let's start by talking about debt. Is it good? Bad? Possible to be both?
Before we dive in, let's review the definition of debt and the types that exist:
Debt, by its simplest definition, is an exchange of present goods for future goods. Today, we're breaking debt into two categories: 1) consumption debt and 2) investment debt.
Let's think of this as a pension system, considering government debt.
If you are in a pension system, you take a reduction in what you could consume via the decrease in your current pay. The government will use that reduction to purchase investments, the profits of which they'll use to pay you back through Social Security and other payment vehicles.
Let's walk through four concerns we're seeing in data surrounding our national debt.
Problem 1: Less Economic Growth
Chart 1 shows GDP growth per capita in developed, emerging, and developing economies. The blue countries represent a low debt burden to production ability within the economy, and the red represents countries with high debt loads. So, if a country is at 30% or less of its GDP debt, it will grow on average of 2.6%, where those with higher debt burdens will be at 1.7%. Therefore, you can conclude that higher debt loads will offset production.
Problem 2: Disincentivizing Investment and Reducing Productivity
The second problem is an extension of the first. One of the best indicators of an economy's future growth is its investment rate. When investment increases, so do productivity, which is accompanied by economic growth. Thus, if countries with less debt grow faster, these countries may see more investment and more significant productivity growth. Chart 2 shows how countries with less debt see more excellent investments.
Another way to look at this is production per work. Ultimately, the wages of workers are dependent upon the output of workers. Production is increased through investing, not consuming.
Problem 3: Deteriorating Solvency
We also see an effect on the amount of debt across the world. For example, the amount of public debt relative to tax revenue has increased in Asia, Latin America, Europe, Africa, and other countries worldwide.
If we go back to the great recession, we see the world's debt has been accelerating. Look at the different regions below and the debt they carried before the 2007 great recession (blue) versus before the 2020 lockdown (red).
Going into the great recession, Japan was at 176% of the debt. Then, going into lockdown, it was at 235%, compared to the United States at 73% before 2007 and 104% in 2020. Therefore, the United States was below average going into the great recession, growing faster than other economies.
Problem 4: The Relationship Between Inflation and Debt Default
The link between inflation and the accumulation of public debt (and sovereign bankruptcy) is relatively recent; as seen in Chart 5, countries that find themselves defaulting on public debt experience more than triple the inflation rate of countries that honor their commitments. However, in the twentieth century, due to the change in the monetary system, it became possible to pay off public debt through inflation.
History Does Not Repeat, but if often Rhymes
We don't know what history will look like, but we have an idea of what it's trying to achieve.
Once again, not just in the U.S. but across the globe, debt is trending upward. Japan is the highest at 257% of debt to GDP, with the United States at 133%. However, you do have some European countries that are relatively low as well.
As we're in an inflationary system, we are not calling on what inflation will be. But since the U.S. government has been making consumption loans, the United States should be positively affected if we get infrastructure spending.
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