This article is taken from the December 2020 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering three issue for just £5.

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Horror stories about public debt are a commonplace. Spending other people’s money comes more easily to politicians than imposing extra taxes. The natural response to a sudden and unexpected emergency — such as that posed by the Covid-19 pandemic — is to expand the budget deficit and to let the public debt increase.

The trouble is that interest on the debt is part of government expenditure. A big deficit this year implies a large increase in the debt, and a large increase in the debt results next year in extra debt interest, yet more spending and another lurch upwards in the debt, which results in the third year in extra debt interest, yet more spending and an even bigger lurch upwards in the debt. Driven by the genie of uncontrollable debt interest, the public debt becomes an ever more powerful and dangerous Frankenstein monster with a life of its own.

The horror stories are indeed a commonplace, and numerous examples of public debt explosions and associated currency debauchery can be found in the historical record. A celebrated book — This Time is Different: Eight Centuries of Financial Folly by Kenneth Rogoff and Carmen Reinhart — was published with beautiful timing in September 2009, just ahead of the crisis in which the Greek government reneged on over $40 billion of its borrowings from private sector creditors.

It is possible — perhaps even quite plausible — that in the four years of the presidency about $8,000 billion of extra debt will be clocked up

However, the historical record also shows that many governments have incurred seemingly enormous public debts and still honoured them in full. For example, Britain has on three occasions had a national debt exceeding 150 per cent of gross domestic product, after the Napoleonic Wars and the two World Wars of the twentieth century. Yet its government has consistently met interest and capital payments as they fall due.

This has been an extraordinary year for the American public finances. In the first three years of the Trump presidency the Federal debt climbed by $3,225 billion, which may sound daunting, but was in fact less than the rise in the first three years of the Obama presidency. But in the one year of 2020 the increase in the debt is likely to be larger than in the previous three years put together.

Overall the Trump presidency will have added about $7,000 billion to the debt total. Whereas at the end of 2016 the Federal debt was under 105 per cent of gross domestic product, by the start of the new Presidency it will be heading towards 120 per cent of GDP.

Ahead of the presidential election, both Trump and Biden said that they wanted another fiscal package — on top of the $2,200 billion splurge under the CARES Act in March — to counter the pandemic’s challenge to the economy. The figure going around for the second instalment was $2,000 billion. With the Senate still under Republican control, that has been pared back to perhaps $1,000 billion. As Biden will inherit a large underlying deficit from Trump, a fair verdict is that the first year of his presidency will record a Federal deficit of more than $2,000 billion.

It is possible — perhaps even quite plausible — that in the four years of the presidency about $8,000 billion of extra debt will be clocked up. Public debt could reach more than 125 per cent of GDP.

Does the horror story of uncontrollable debt interest then start to become realistic? Amazingly, it is not at all realistic given the current mix of political conjecture and market anticipation.

The current yield on ten-year US Treasury bonds is a mere 1 per cent and on shorter-dated paper it is even less, at little more than 10 or 20 basis points. Even with a public debt of over 125 per cent of GDP, the implied burden of debt interest is minuscule, a mere 1 per cent or so of GDP.

On the face of it, the fiscal excesses of the Obama-Trump-Biden era are a matter of indifference to investors, and the Federal debt can rise much more before an explosion in debt interest confronts the American political elite with unpalatable choices.

The problem here is that the sustainability of the public debt depends on the credibility of financial policy, while the credibility of financial policy depends on the sustainability of the public debt. Only a minority of financial market participants believe that a significant upturn in inflation is probable once the medical emergency has ended and the economic situation returns to normal. But they may be right.

In the year to June the quantity of money rose by over 25 per cent, the highest figure since the Second World War and well above the peak figures in the inflationary 1970s. Let it not be forgotten that in 1979 the increase in US consumer prices was more than 12 per cent and that in autumn 1981 the yield on the US 30-year Treasury bond briefly went above 15 per cent. If public debt were 125 per cent of GDP and the average yield on it were 15 per cent, the cost of debt interest would — by itself — be approaching 20 per cent of GDP.

This is not a forecast that the US in the 2020s will go the way of Greece in the early 2010s; it is a warning that the laws of arithmetic apply to every nation, including that with the world’s largest and most important economy.