Debt—public and private alike—has always played a central role in economic growth, but when it reaches overwhelming levels, it can hamper the economy, dilute real incomes, and lead to a chasm in wealth distribution.
Capital owners usually fare better as debt often inflates asset values, albeit temporarily until the bubble pops.
The U.S. Debt Ceiling Discourse: Beyond the Rhetoric
The recent U.S. debt ceiling saga was marked by Republicans’ fixation on the nation’s deficit, with their negotiation efforts often diverted towards highly political matters like cutting off funds for the Internal Revenue Service.
The fact remains that the portion of the federal budget that was up for negotiation only comprised 15% of total spending. Thus, instead of the federal debt rising to 119% of GDP in a decade, it will now rise to 115%.
This might seem like a minute adjustment, but the debate overshadowed a significant aspect of the discussion—the government debt’s contribution to the household sector’s growth.
Former banker Richard Vague, presently Pennsylvania’s Secretary of Banking and Securities, outlines this point in his forthcoming book ‘The Paradox of Debt’.
He emphasizes that in 2020, during the COVID pandemic, as the U.S. government’s deficit touched $3 trillion in the bid to salvage the economy, the nation’s overall wealth augmented by around $11 trillion. The net worth of U.S. households soared by $14.5tn that same year.
The Debt-Growth Paradox
From 2019 to 2022, during the pandemic’s triennial span, while the government’s net worth declined by $1.7 trillion ($6tn at the federal level), household net worth ballooned by $30.9 trillion.
This growth was observed even when considering last year’s stock market dip. The reason being, government debt metamorphosed into household income and spurred the growth of asset wealth, including stocks and home values.
The correlation between rising debt—both public and private—and growth has been apparent since the 1980s.
Vague highlights that the government debt and spending model ensure the benefits of government spending are shared by non-financial businesses and households.
The distribution varies—for instance, in the U.S., households are the primary beneficiaries, while in Japan, non-financial businesses receive the lion’s share of benefits.
Two exceptions to this model are Germany, where trade surpluses foster growth, and China, where non-financial sector debt supports household income.
The Debt Predicament: Rising Inequality and Economic Drag
While debt indeed stimulates growth, it brings along its set of challenges. The foremost is the accentuated inequality resulting from rising debt, as higher asset values are primarily pocketed by the wealthy.
This trend has been quite prominent in the U.S. since the late 1980s, which marked the start of financialisation.
Moreover, the increasing private debt weighs down economies as household debt servicing becomes a burden for the less affluent.
The debt-driven growth cycle, centuries old, usually witnesses governments using debt for wars, followed by a private sector resurgence leading to greater financial lending. Eventually, excess lending necessitates government bailouts.
This repetitive process, apart from being draining, results in economic and political instability—from stock market crashes and housing crises to debt ceiling standoffs and popular backlashes against the affluent.
As we grapple with navigating beyond the debt-driven growth cycle, Vague suggests ways to curb dangerous debt excesses and prioritize diverse stakeholders when inevitable defaults occur.
A key takeaway is that the rate of debt accumulation is as critical as the total debt amount. Policymakers are advised to closely monitor this metric across both the public and private sector.