The writer is a financial journalist and the author of “More: The 10,000-Year Rise of the World Economy”.
Absence doesn’t matter. This quote doesn’t come from some wasteful European socialist, but supposedly from the decidedly conservative Dick Cheney, Vice President of the United States from 2001 to 2009.
According to former Treasury Secretary Paul O’Neill, Cheney cited the Reagan administration as evidence for his thesis in 2002; the national debt tripled on the Republican watch in the 1980s, but the US economy boomed and bond yields fell sharply.
In the 20 years since Cheney’s remarks, the U.S. federal debt as a percentage of GDP has roughly doubled. But 10-year Treasury yields are no higher than they were two decades ago; in fact, they spent much of the intervening period at much lower levels, even as debt soared. The ongoing uproar over the US debt ceiling has nothing to do with markets’ willingness to buy US debt, and nothing to do with politicians’ willingness to honor their government’s commitments.
However, Cheney’s sentiments have not always been vindicated elsewhere. Over the past nine months, the UK government has discovered the problems that can occur when funding costs rise suddenly. And this has revived the debate about whether governments are capable of running a prolonged deficit.
In one camp are the spiritual descendants of Margaret Thatcher, the former British prime minister who sought to balance the budget, arguing that “good conservatives always pay their bills.” Modern fiscal hawks often say that governments should not pass the burden of debt repayment onto the next generation. Many also argue that the budget deficit is caused by excessive government spending, and that reducing that spending is not only prudent, but promotes economic growth. In the other camp are most economists, who argue that, unlike individuals, governments are actually immortal and can rely on inflation or future generations to pay off their debts.
They point out that public debt relative to gross domestic product was very high (both in the United States and the United Kingdom) after World War II. This debt did not hinder rapid economic growth. In addition, the aging of the developed world’s population means that there has been a “savings glut” as citizens put money aside for pensions, making it easier to finance deficits.
However, the freedom for governments to issue debt comes with some caveats. First, a country must be able to issue debt in its own currency. Many developing countries have discovered the dangers of issuing debt in dollars. If that country is forced to devalue its currency, the cost of servicing its dollar debt will soar. Second, countries need a central bank willing to support their government by buying debt. Quantitative easing programs for such purchases have undoubtedly made it easier for governments to run deficits.
In the Eurozone crisis of 2010-2012, the deficit was also important for countries such as Greece and Italy. Their bond yields surged as investors worried that indebted countries would be forced out of the eurozone. This would have either forced governments into default or attempted to rewrite the debt into the local currency. Greece turned to its neighbors for help, but found other countries unwilling to provide the necessary support unless Athens reined in its budget deficit.
For many Eurosceptics, joining the single currency proved foolish. Britain was exempt from such austerity because it issued debt in its own currency and had a central bank that undertook QE. Given these freedoms, last autumn’s financial crisis, which followed the mini-budget proposed by the short-lived Liz Truss administration, was even more shocking.
While Truss tried to echo Thatcher’s imagery, she dismissed the Treasury’s budgetary prudence as “abacus economics”. He argued that tax cuts would lead to faster economic growth, so the deficit would disappear on its own as government revenues rose.
However, the markets did not swallow the argument. The mini-budget was followed by a spectacular sell-off of the pound and British government bonds. The latter may have resulted from leveraged bets on bonds by British pension funds. However, the Truss team’s economic analysis did not consider this possibility.
Investor confidence in British economic policy has already been shaken by the Brexit vote and the rapid change of prime ministers and chancellors. The problem hasn’t gone away. Figures released this week showed Britain was still struggling to contain inflation, with gilt yields jumping back towards levels reached after the mini-budget.
So Cheney’s aphorism needs to be modified. The deficit does not matter if the state borrows in its own currency and has a friendly central bank, steady inflation and the confidence of financial markets. It also requires a continuation of the global savings glut. These conditions mean that there is plenty of room for future governments to get into trouble.