Friday, October 18, 2013

The truth about government debt

Jim Stanford writes an enlightening piece about government debt titled, The only thing we have to fear? Fear of debt itself.

Nothing personal

The first mistake people make about government debt is equating it with personal debt. It is actually more like corporate debt.

People have life cycles: they get in debt young buying a house. Then they eventually pay off the house and save money for retirement. Governments don't have life cycles.

Debt burden

A government's debt burden is measured in debt/GDP. (Debt divided by GDP.) The higher the number the worse it is.

This means there are two ways of paying down debt: a) decrease the debt directly by running a budget surplus; or b) increase economic (GDP) growth — grow our way out of debt.

Austerity in a slump

John Maynard Keynes — the father of mixed-market economics which created modern living standards in the post-war era — summed it up best: “the boom, not the slump, is the time for austerity.”

What happens when debt is paid down in a slump? It causes GDP growth to slow — or contract (a recession) — which makes the debt burden worse!

Self-defeating austerity

This is why bond-rating agency Standards & Poor's panned Europe's austerity plan of 2011:

We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

Post-war way

After WW2, governments had far greater debt burdens that we have today. How did they approach the problem? They spent money big time!

“Canada finished the Second World War with public debt equal to over 150 per cent of GDP. But we never obsessed about ‘paying off’ that debt. Instead, policy-makers unleashed decades of vibrant growth — not by cutting public spending but by increasing it, on things like highways, seaways, medicare and pensions.”

This produced unprecedented economic growth — an economic golden age — where all levels of society benefitted — not just the rich (like over the past 30 years.)

Using the mixed-market method we paid down debt to 17% (!) by 1973. It's now back up to 87%.

Conclusion

Thirty years of free-market reforms have caused all the economic problems we face today — including the global economic meltdown of 2008. It's time to abandon failed ideology for what's proven to work wonders: centrist Keynesian economics.

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