Trillion dollar deficits are the new normal

Welcome to the age of perpetual debt in which governments keep borrowing money even when the economy is doing just fine.

Never before has money been this cheap. And for such a long period no less.

Money was only meant to be cheap for a short time.

The economy’s engine sputtered and fluttered in 2007 and 2008.

Central banks did what they always do when that happens. They cut interest rates to make money cheap. Cheap to borrow, to be precise.

Cheap money was the oil central banks added to keep the engine going before it would stop completely.

But even someone with only a basic understanding of how an engine works knows that an engine running on too much oil is as bad as one running on too little.

It leads to different kinds of trouble.

Of course you can’t have the economy grinding to a halt. You get a crisis and it takes a while before that motor is up and running again.

But flooding the economy with cheap money – like flooding an engine with oil – is potentially even worse.

It threatens to destroy the whole damn thing!

Thanks to cheap money, global debt is at a record high and growing faster than ever before.

How do the economy’s mechanics expect to fix this mess?

Half listening to Keynes

Cheap money helped central banks stave off a crisis, but it came at a price.

That price is debt. A lot of it.

The current tally stands at $247 trillion, or 318% of global GDP.

That’s more than three times what all the good people on earth produce in a year! If all we did for three years was pay off debt, we’d still be in the red…

When you’re already so deep in debt that there’s no chance you’ll ever repay it, why bother trying?

Besides, money is still dead cheap as central banks haven’t meaningfully raised interest rates yet.

So we merrily keep on adding to the debt pile.

We’ve already added $9 trillion this year, and $30 trillion since the start of 2017.

That’s worrying in the worst of times when we actually need debt to get the economy going again.

But with most developed economies growing again, it seems now we’re just borrowing for fun…

What’s that thing John Maynard Keynes wrote about fiscal policy?

It’s fine for governments to boost spending during a recession to make up for a shortfall in demand.

This way you’d be “leaning against the wind” and go against the economic cycle in an effort to get it out of its funk.

But when the wind turns, you have to stop leaning or you’ll fall over.

Governments have to reduce spending and try to run a surplus in economic booms to pay for the money borrowed when times were bad.

“Even Keynesianism, generally the most debt-friendly (…) school of economic thought, views deficit spending as a cyclical stabiliser,” writes analyst John Rubico.

“But now we seem to have turned that logic on its head, with fiscal stimulus ramping up in the best of times, when unemployment is low, stock prices high and inflation stirring.

“New Age fiscal policy seems to call for continuous and growing deficits pretty much forever.”

These days politicians only half listen to Keynes.

They run deficits when the economy contracts (like Keynes says) and they run deficits when the economy expands (not like Keynes says).

Colleague Brian Maher dubs it “the religion of perpetual debt”. It works a little like this:

The economy is doing well?

Let’s pile on debt.

The economy is doing badly?

Let’s create a lot more debt.

The economy is getting better?


At least it’s easy to remember.

The new normal

“The trouble with socialism,” said Margaret Thatcher, “is that eventually you run out of other people’s money.”

That statement has proved to be false on two accounts.

Mrs Thatcher probably lived long enough to know that no political ideology has ever stopped governments from borrowing tons of money.

Remember George Osborne who was going to balance the books and even run a surplus?

When he headed the Treasury UK national debt actually rose by £555bn between 2010 and 2016.

The UK government owed £1.78trn (86% of GDP) as of the first quarter of 2018.

And despite our best efforts we haven’t managed to run out of other people’s money yet…

The worst offenders of the most advanced economies are Japan (240% of GDP) and the US (108% of GDP).

I’ll repeat, globally we currently live with $247 trillion we don’t have.

Isn’t that going to have consequences?

Why yes.

Eventually interest rates will have to rise.

Be it because it’ll be the only way to attract investment capital, be it for the central banks to be able to cut rates again in a recession.

Let’s see what that would do to the financial health of the US:

“If the interest rate on [US] debt were to rise by even 1%, the annual federal deficit rises by $200 billion,” writes financial analyst Daniel Amerman.

“A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.”

Let’s remember for a moment that interest rates of 5% are really very normal, historically speaking. It’s this period of low interest rates that’s the anomaly.

If central banks don’t just talk about “normalising” monetary policy, but actually go ahead and do it, then trillion dollar deficits could become the new normal.

All of a sudden it becomes crystal clear why central banks like the Federal Reserve, Bank of England, ECB and Bank of Japan have been so reluctant to move away from emergency policies.

If monetary policy goes back to normal, we’d pretty soon find ourselves in another emergency…

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