Our video today is very hardcore Let's talk about a topic that is arguably the centre of the financial universe Very interesting and intricate Very suitable for me to talk about it That is Government Debt This is the trend of the U. S. debt to GDP over the past 25 years Now it's over 120% Britain, the Eurozone and China at what seems like an incredible speed increase their own country's government debt And the most outrageous the world's most prolific borrower is Japan The government debt is the highest in the world at 260% of GDP What does this number means?
It takes every person in Japan 2. 6 years to make enough money to pay off their national debt If you look at the revenue of the Japanese government in 2022 If they don’t eat or drink or spend any money not even a cent then it’ll take them 18 years to clear the debt Have the government of these countries gone crazy borrowing so much money What’s the logic behind it? Will US default on its debt Why do some economists say its better for government to borrow more and more money how much money is considered a lot?
To be honest when I was crafting the script for this episode I believe the contents are valuable I try to make it easy to understand If you think this video is useful You can save it as favourite This will make your collection more valuable Every government makes money and spends money This is US government’s income for the past 30 years 95% of them comes from tax This is their spending They spend their money on public utilities like National defence, military, infrastructure, etc You will find that most of the time they spend more than they earn In technical terms, it's called constant budget deficits Where did the extra money come from? Government would issue bonds to borrow money from the market to make up for this part of the funding gap. You can see the fiscal balance of China, Japan, UK and Eurozone they are all in constant deficit If you just look at this financial situation if it’s your next door neighbour then he is probably a prodigal But that doesn't seem to hold true for a country Let’s first take a look at debt ceiling, a topic heavily debated for past few days In order to control themselves so that the government spending won’t go too high there exist a symbolistic system called Debt Ceiling The congress would vote on deciding the line The treasury cannot borrow money beyond this line This sounds like a reasonable restriction and self-restrain But why did I say it’s symbolistic?
Once the debt nears the ceiling the Congress would immediately held a vote When it’s getting close, there’ll be a vote When it’s getting close, there’ll be a vote So from 1981 till now In 42 years the debt ceiling has been adjusted 42 times On average, it is raised once a year Actually everyone knows that if there’s a problem with US debt like a default then the blow to the entire U. S. economy would be devastating White House predicted that if the default lasts for a few weeks it would lead to a 45% drop in the U.
S. stock market More than 8 million people would lose their jobs In short, the consequences are very severe So this debt ceiling mainly gives the two parties an opportunity to quarrel Now Biden’s Democrats is in power but in Congress majority is Republicans So the Speaker of the House, McCarthy wanted to take this opportunity to force Biden to reduce financial expenditure So both sides are negotiating this financial mechanism Two years ago when Biden threw in $5 trillion to stimulate the economy, they didn’t do anything Now they want to start negotiation when the debt ceiling is close Actually there aren’t many countries in the world that has debt ceiling Other than US, there is Denmark But Denmark debt ceiling is very high Three times their current debt so the debt ceiling is basically just a farce There is really no country in the world that restricts its own country's debt issuance because of debt ceiling For the past 50 years Global government debt continues to rise Why do you think they are borrowing so much? What are they thinking?
Are they not happy? Lin is going to give you a Economic 101 First we have to understand what is the problem we are trying to solve Government borrows money to spend the problem is why are these governments spending so much money? The father of modern economics the one who introduced The Invisible Hand, Adam Smith he actually was very against government spending He believes that market competition is the most efficient So the less the government manages, the better.
the smaller the better If you borrow so much money and spend so much money it is very irresponsible US followed his theory from 18th to 19th centuries. encouraged competitions The government would not regulate anything But slowly the problem arises he realised that If the market is completely free to compete the economy will collapse every once in a while the economy will collapse every once in a while The worst was the Great Depression in 1929 In the face of such a great depression US government was firmed on their practice I don't want to intervene too much in the economic cycle Unexpectedly, this depression lasted for more than a decade Afterwards, many economists believe that the reason why this depression can last for so long is due to government’s inaction. Under the background of this era another great economist appeared John Maynard Keynes He put forward a set of new theories adopted by the governments over the world The most succinct summary is that the market will also fail so the government cannot ignore completely especially during economy downturn People are not willing to spend money demand is sluggish So government should borrow money and spend it to increase aggregate demand and prevent economic crisis Of course Keynes's theory was later disputed However Its core has been gradually accepted by governments across the globe When the economy faces a crisis or recession The government has to borrow and spend money vigorously Stimulate the economy Only in this way the economy can get out of crisis Did you notice that whenever there is a crisis the government will start spending money US 2008 subprime mortgage crisis 2020 pandemic 1998 Japan financial crisis 2008 subprime mortgage crisis 2011 earthquake Euro debt crisis Not sure if it is a coincidence but lately there are quite a lot of crises so governments accumulated large amount of debt But it doesn't mean that the money spent is useful For the past 30 years Japan has been borrowing money but their GDP is motionless What we said just now is the theoretical basis for government spending Let’s expand it a little Recently, this theoretical basis has been upgraded An economic theory that subverts previous theory became popular Modern Monetary Theory (MMT) The theory believes that Governments should be able to borrow freely Because the more the government spends, the more money the non-government side of the market makes The government's credit is essentially money As long as there is no inflation Then borrow and spend as much as you can This is the best for the economy Of course this theory is not yet accepted by mainstream economics but it really is very popular these days that’s why I mention it Alright, even if the government can borrow and spend money they can promote employment, stimulate economy Could they be borrowing and spending money endlessly This definitely doesn’t sound reasonable There must be a limit However the limit is definitely different for people like us Because government possess capability that we do not have and that is printing money Some might disagree Lin you’re wrong How could government print money Only central bank can print money, government can only borrow That’s right, theoretically that’s how it should be Most of the well-established systems also separates the government from the central bank.
The government can't simply print money from the central bank and spend it But actually, there are ways the government can work around it The simplest one would be the central bank cannot print money and give it to government but it can buy government bond right Isn't this what Quantitative Easing does? Essentially it is government borrowing money from central bank This is actually the difference between domestic debt and foreign debt The one we mentioned A country's using bond issued locally is internal debt Maybe back in the days of using gold standard it is restrictive for government they wouldn’t dare to print money without limit But now it is easier for government to evade default by printing money Money borrowed overseas are usually debt denominated in USD and this is external debt No one can print money other than US If you really have a cash flow problem you can only borrow from others This is the time when it's very vulnerable to default If we say that internal debt is a buffer period for economic activities Then external debt is amplifier of economic activity It’s easy to understand because debt itself is leverage When the economy is good the capitals would all come to you then you can magnify your advantages then you can magnify your advantages but once there’s a problem and the capitals withdraw it’ll exacerbate the crash Actually throughout history many national level economic crash debt crises are mainly due to default on external debt In the 1970s and 1980s Latin America was growing fast and attracted a lot of external investment Two oil crises in the 1980s USD raised interest rates Latin America had to follow suit causing their debt grew further External debt was increasing In the end, Argentina, Brazil, Mexico all defaulted on their debt The American investors lost their money, too Euro debt crisis lasted for so long is because Eurozone in my opinion is a bit troublesome Before this, I’ve mentioned in Greece and Euro debt crises videos In the beginning these European countries all huddled together and created a central bank to print money but their fiscal policy is a separate business This is turning internal debt into external debt But Greece, Italy and Spain were facing a problem Their national debt is at risk of default European Central Bank can’t break the rule can’t break the rule right So they can only borrow money from others EU and IMF lent money to them but they are also forcing them to tighten up expenditure This caused further problems for these countries Their economy was already weak and now they had to tighten up This fiscal policy was supposed to be an economic regulator, but instead it increased economic fluctuations This is the problem with external debt 1997 Asia Financial Crisis 1998 Russia and Ukraine default 2001 Argentina Financial Crisis including last year’s Sri Lanka The direct reason for their crash is because default on external debt This is why some people said internal debt isn’t debt Although this theory is a bit extreme internal debt is certainly a debt but it's much more controllable Governments can borrow more comfortably in an emergency without worrying about short-term defaults So looking from this point US has their particularity They don’t have to worry about internal or external debt for them it is all internal debt The dollar, of course, is another topic Alright just now we talked about the government borrows money differently than we do It's not money or the debt ceiling that restricts government borrowing So what exactly is restricting it? Lin dive deep and found that The biggest debt crises in history can be summed up in two ways First is interest rate Interest rates are at the heart of financial markets and national debt is the core of the interest rate because its price determines the risk-free rate You will find that bond issued by companies for example Microsoft, Amazon, Petrochina their interest rate is highly related to government bond rate because its pricing is determined by the interest rate of government bond If more government bonds are issued the supply will increase, the price will drop and the corresponding risk-free interest rate will rise Interest rates across the economy will rise accordingly The effect is almost the same as raising interest rates.
What’s the effect of raising interest rates? I believe everyone would have some understanding on this and that is suppress consumption, suppress investment suppress economy, suppress everything Maybe it confuses you a bit Isn't the rate hike controlled by the central bank? how is it related to national debt again?
We have talked about this in previous episode To put it simply Central banks control short-term interest rates National debt control long-term interest rates In addition to suppressing the economy the rise in interest rates has a more direct consequence for the government The cost of issuing debt simply goes up If they want to take new debt they’ll have to pay higher interest It’s like if you get into more car accidents then the insurance become more expensive Too much government debt raises interest rates If the rate is too high to a point that the tax received is insufficient to pay for interest how can they stimulates economy don’t bother think about it The government will become a fund that provides fixed income to global creditors They’ll get into a spiral of debt uncontrollable, borrow more and more This idea is not extreme at all For example, Japan's debt If the average government interest rates is as high as 5% Then all the government revenue is not enough to pay the interest. Of course, this is not the case in Japan. Although their debt is the highest in the world but their current fiscal revenue is only 11% they spent it mostly on interest rate For the past few years although they are borrowing more but the interest paid is less This is because government has a way to counter the rise of interest rate All the things we’ve talked about is slowly connecting This method is Quantitative Easing Since 2013, Japan has been following Abenomics and borrowing a lot to stimulate economy But he was worried about borrowing too much causing a rise in interest rates The central bank is responsible for printing money to buy government bonds Once demand increase price increase, then the interest rate can be lowered It's better to get it down to almost zero After that, the government can borrow money comfortably without worrying interest rate hike Until 2020 Japan government couldn’t be bothered to pretend They laid it all out They just want to do unlimited QE Their goal is in the open and that is to push down 10 years yield to below 0.
25% After battling with capitals in the market it has been increased to 0. 5% still there’s a limit After 2013 Japan's central bank holdings of government bonds risen because the central bank continues to buy government bonds to push down interest rate This allow Japanese government to pay lesser interest despite borrowing more money Don't think that central banks are printing money purely to put a little more money in the economy It has a very important target and that is to lower long-term interest rate Not only in Japan, QE in US, Europe produced the same results Every time someone questions whether the U. S.
Treasury is borrowing too much Treasury Secretary Janet Yellen will come out and say although we borrowed a lot but the interest rate is very low The interest rate we pay now is not as high as it was in the 90s The implication is that Borrowing is cheap and it helps stimulate the economy then why wouldn’t I borrow? So you see the first restriction on borrowing, interest rate can be lowered through cooperation between government and central bank But there’s no free meal in the world There is one restriction which the government cannot get around The one topic that concerns governments, central banks and economists and that is inflation We have published videos for these two topics respectively Inflation is the one matter that troubles many governments They can use money to pull demand They can use money to stimulate employment But when it comes to inflation, there’s not much they can do Other economic problems now seem trivial Central bank can no longer suppress interest rate artificially nor use smart-ass policy to curb Countless historical experiences have shown that the only solution is taking austerity measures This is akin to chemotherapy Kill all the cells both good and bad Cooling prices by suppressing the overall economy There are some governments who couldn’t go through with it so they continue to borrow and stimulate economy This risk them falling into hyperinflation Venezuela was in that position few years ago You must be wondering now that US inflation is so high why are they still increasing debt ceiling? This is because they have spent all the money, there’s no other way If the US government knew that the stimulation in 2021 would bring such high inflation, The Fed raising interest rates frantically, and the global economy in recession they wouldn’t dare spending so much money Now that you have an understanding on the two restrictions now let’s take a look at how much bond issued is good for some countries or is considered normal As long as they don’t touch on these two restrictions Issuing bonds is about trade-off between growth and stability They can have different strategy or different style Some countries which are relatively stable like Denmark even though they have debt ceiling, but it’s not useful Debt to GDP ratio has been below 50% Countries like Sweden, Netherland, Switzerland are similar They don’t pursue high economic growth they do it step by step US and Japan are both pursuing rapid growth China has different system the central is quite stable but for local bond or municipal bond then there are more problems to that Anyway, no matter how much debt a country chooses to issue these two are the bottom lines If they issued too much causing a hike in interest rate or suppress economy or unable to repay or they issued too much until there’s a rise in inflation then there’s a risk of losing control At this time the government debt is definitely too high So the red line for debt is not an absolute number nor is it an absolute ratio to GDP It is based on the economic environment of the country If interest rate and inflation is low and people have confidence towards government Even if you keep borrowing and the number may seems too big but it could be nothing for the economy Before pandemic, that’s how it is for US, Japan and Europe Even if Japan’s debt is so high only the media would make some noise The financial market is still relatively stable but the environment is different now Let’s look at the interest rate on ten-year US Treasury bonds 3 years ago was 0.
6, now is 3. 7 Inflation is even higher 3 years ago inflation was 0 now is 4. 9 Not only US it’s similar in Japan and Europe So you see Japan's 260% debt ratio Two years ago it didn’t look so high but now it poses a problem If one day UK government realised that they issued too much government bond, inflation is rising the road is getting narrow What can they do?
Then the choice will definitely not be so easy. There are three roads ahead First the more direct way austerity You borrow too much so spend less and borrow less Simple as that For example US government Often because the budget is not approved they had to shut down for few days or few weeks In 2009 they shut down for the longest time in history 35 days Across US, more than 800,000 civil servants had not been paid for more than a month This kind of small scale austerity can't solve the problem at all Large scale intense austerity will definitely bring an immediate hit to the economy. So governments need a lot of courage to implement this kind of policy They will also face strong resistance when implementing the policy 800,000 people didn’t receive wages They wouldn’t take such drastic measure if they had not been forced to a certain degree Like Europe debt crisis Italy, Greece, Spain always these countries In 1997 Asia Financial Crisis, Korea they all implemented very strict austerity policy to solve debt issue Do you think they have self-conscious?
Of course not This is because they have external debt They had to borrow from IMF The creditors must have forced them to retrench In the face of debt problem there’s a second road This is more radical and that is by defaulting or debt restructuring Many of you may not be clear on what would happen when a country default Country default is not the same as how a company default not as disastrous selling off all your assets and dissolve immediately When government goes bankrupt investors can’t do much about it Over a century ago it was indeed solved by force When Venezuela went bankrupt in 1902 the creditors, Germany, UK, Italy dispatched army and blew up the ports to force Venezuela to pay But now such thing will not happen Now when a government default the biggest consequences is decline in credit Then the cost of financing will be high and it will be hard to borrow money This is a serious case because now an economic body is based on credit The more advanced the economy, the more it depends on credit Once government default entire country’s credit market will crash Everyone would avoid it Then the currency market will plummet They would take a really long time at least 8 to 10 years to slowly recover This shows how serious the blow is The US government predicted that defaulting on few interest rate terms would cause 8 million people lose their jobs However this doesn’t mean there won’t be a default on internal debt Lin counted that from 1980 to 2022 In these 42 years There are a total of 84 internal defaults around the world I counted it one by one What I found interesting is that Internal default for larger country is at the same time with external debt default For example, Russia in 1998 Argentina in 2001 Greece in 2012 Their main problem is on external debt When the government see that they are defaulting on external debt their credit will definitely face a huge blow then might as well default on internal debt and won’t even have to pay back debt or print less money For the past 20 years, Argentina had bankrupted 3 times The two roads we mentioned, austerity and default are not common options Most government would take this route I think you know what it is that is drag it How do they drag it? Either by borrowing money to pay back old loan or simply print money or both at the same time Generally when government facing debt problem it’s when economy is sluggish accompanied by high inflation At this time if they spend money to stimulate for example stimulate EV industry and suddenly there’s a technology outburst that brings about improvement in productivity Then the economy will be expanded inflation will be digested by growth Government finances will stop going downhill The economic problem is thus easily traversed But of course the possibility of this is too low If they continue to borrow and print money the most probable outcome is it becoming worse If they keep dragging that is certainly irrational and unreasonable But this is what most countries choose to do when facing debt problem This doesn’t mean the government is procrastinating This is actually due to political system They are often elected by terms Even if economists and government official do not want to drag but the citizens don’t want to face austerity and they can’t stand government defaulting In these 3 solutions Only dragging is expansive It’s the least painful in short-term This kind of policy is definitely popular amongst the voters If you watched the episode on Greece you’d now how undependable voters are Did you realise a lot of the topics are now connected Today, on the topic of government debt we talked about US debt ceiling Why governments borrow money The difference between internal and external debt What are the factors limiting debt issuance What to do when issuing too much debt Quite hardcore right For this episode I spent a lot of time scripting not a lot of stories told with the hope of laying the framework down in one go and help all of you to understand more macro economics and fiscal policies of various countries To those of you who watched till now Let me give you a Like and hope you can give me one too!
