The U.S. federal government has been paralyzed for two weeks by a lack of budget spending authority, with hundreds of thousands of federal employees off the job. And that’s just the immediate economic fallout from a political showdown over whether the U.S. government will be allowed to borrow beyond its current $16.7 trillion (U.S.) debt ceiling. Without that authorization, many more government operations would cease immediately, and the U.S. would likely default on some of its existing debt. Perhaps most painful of all, even the best-case outcome to this week’s drama seems to be a compromise that would permit four months’ additional borrowing — merely setting the stage for another showdown in February.
This latest manifestation of American political dysfunction has roiled the markets for weeks. And they will be roiled again, no doubt, when it happens all over again next year. Perhaps counter-intuitively, however, financial investors were not losing sleep over debt itself. Neither were economists. Deficits and debt are symptoms of continuing trouble (namely, weak spending power and disappointing job-creation), but they are not the cause. Financial and economic experts grudgingly accept that huge public debts will be part of the economic landscape for years to come. In fact, down on Wall Street they’ve learned to love debt — especially the $85 billion the U.S. Federal Reserve pumps into asset markets every month.
To the contrary, financiers and economists alike were fretting that the U.S. might suddenly stop borrowing. It’s the potential freezing of debt, not its continued escalation, that evoked nightmarish scenarios of financial meltdown and renewed recession. In other words, the problem is not that debt is too big. The problem is that debt-phobic politicians (like the Tea Party), motivated by a general ideological suspicion of “big government,” might successfully erect roadblocks to the continued orderly growth of debt.
Worldwide, too, it’s increasingly clear that misguided efforts to reduce public debt, not debt itself, poses the greatest threat to a still-shaky global recovery. In Europe, for example, ultra-orthodox financial bureaucrats at the EU and the European Central Bank put rapid deficit-reduction ahead of growth. But that did far more harm than good; even the International Monetary Fund now acknowledges that massive fiscal cuts have needlessly lengthened Europe’s depression. So the ECB has changed course, and now facilitates new debt (including by guaranteeing sovereign bonds) — precisely because it’s essential for continued recovery.
Meanwhile, Japan’s debt now exceeds 200 per cent of GDP, with nary a whisper of impending doom. Old models that predicted economic disaster as soon as public debt exceeds some arbitrary threshold have been discredited. So long as a country controls its own currency, and so long as spending by businesses, export customers, and households is insufficient to absorb economic slack, then increasing public debt is not only tolerable: it’s actually optimal.
The same truth is apparent in history, too. Canada finished World War II with public debts many times larger than today’s: equal to over 150 per cent of GDP in 1946. Intelligently, however, we never obsessed about “paying off” that debt. Instead, policy-makers unleashed decades of vibrant growth — not cutting public spending, but increasing it (on highways, seaways, medicare, and pensions). Thirty years later the debt was twice as large in absolute dollars — but had shrunk to a tiny fraction of GDP. Postwar experience proved it’s far more effective to expand the denominator of the debt-to-GDP ratio, rather than fruitlessly trying to shrink the numerator.
Here in Canada we’ve experienced austerity “lite” since the global financial crisis: no historic showdowns like the U.S., no catastrophic cuts like Europe. But we’ve experienced austerity all the same, and the miserly decline in government spending has only undermined an already sluggish recovery. The speaking points of conservatives claim that Canada’s fiscal “prudence” has been our ace in the hole. But that argument is based on ideology, not facts. Relaxing our own phony debt “ultimatums” (like the federal government’s promise to balance the books by 2015, and Ontario’s similar pledge to do the same two years later) would allow the public sector to once again contribute to growth, instead of suppressing it.
We should accept the growing international consensus that more public debt is helping the recovery, not hurting it. In short, we have nothing to fear from debt, except an ideological fear of debt itself.
Jim Stanford in an economist with Unifor. A version of this commentary was originally published in the Globe and Mail.
Photo: Stephen Little/flickr