The scourge of government debt


There has been much debate about the need to revive Keynesianism, government stimulation of the economy versus austerity. In many respects the debate is irrelevant. It is not dealing with the world as it currently is. A lesson is emerging from the current crisis, and for that matter the financial crises of the last two decades, ever since the Latin American debt crisis of the 1980s. Sovereign debt creates risks that private debt does not. With the exception of America and Japan, governments cannot really afford debt, even though government debt is only about a quarter of global conventional debt and a fraction of the out of control unconventional debt created by the private sector. In this world of market states, private debt is not subject to reasonable limits, while the buck very definitely stops at the desk of public debt. Partly because private debt can be bailed out by governments, but there is no-one to bail out public debt and partly because of the climate of anti-government sentiment. A dangerous set of parallel universes, in other words, reckless libertarianism on one side and excessive blame on the other.

Witness the current demonisation of the Greek and Italian governments, and the leadership of the European Union. It is a familiar moralistic refrain that is at best a partial picture of what is wrong with the global financial system, at worst downright deceptive. Post hoc, sovereign debt crises can always be readily blamed on governments because they are the obvious culprits. That is, they allowed the debt to occur. The problem is that while the criticism is true, it is only part of the story. The post hoc analyses miss the elephant in the living room: that such crises were made possible by the globalisation of the capital markets. Instead, it so much easier to blame those foreign governments. We saw this in the financial crisis when Asian “crony capitalism” was blamed as if the developed world doesn’t have crony capitalism!!!). The Russians are corrupt, the Mexicans are so Mexican, the South East Asians haven’t grasped what capitalism really is, you can’t trust those Argentineans etc.

The developing world learned their lesson and have been stockpiling foreign exchange, which actually has contributed to the savings imbalance of recent times. It is why FDI has been flowing from the developing world to the developed world, and not the other way around. After the developing world protected itself from capital markets, the emphasis shifted — to Europe. Now we have more foreign governments to blame. Even though Italy was acting reasonably responsibly, as was Spain, the neo-liberal moralists are queuing up to point the finger.


John Quiggin, writing in the Australian Financial Review, points out how partial this picture is:

With the arguable exception of Berlusconi, none of the leaders swept into oblivion in recent weeks bore any real responsibility for the crisis that engulfed them. Papandreou was only elected in late 2009 when the sovereign debt crisis, driven in part by the irresponsibility of his predecessors, was well under way. Spanish PM Jose Zapatero had been prime minister since 2004 but, until the emergence of the global financial crisis, Spain appeared a model of fiscal probity, running a string of budget surpluses.

Berlusconi was too focused on fending off a string of inquiries into his various political and personal improprieties to do much of anything in terms of policy. Nevertheless, the ratio of Italian public debt to GDP was falling over much of the decade leading up to the crisis.

The debt crises facing Spain and Italy are not the product of government profligacy, and even in Greece, fiscal mismanagement is only part of the story. The fiscal crisis is a continuation of the global financial crisis, which in turn arose from the desperate chase for high-risk profits by European and Wall Street banks, the costs of which have ultimately been borne by the public.

If we accept that the problem is excessive debt, then it is worth asking who produces the debt. According to McKinsey , in 2010 the total value of all debt was $158 trillion. Only a quarter of that is public debt. Over the previous year government debt soared as they sought to bail out the financial system — it was up 12 per cent and accounted for 80 per cent of net new borrowing — but it is still much smaller than private debt. And then there is all the confected private debt (meta-money) that is associated with derivatives and scams like high frequency trading, which is mostly unmeasurable but is certainly part of the financial system. Factor that in, and government debt is seen as a comparatively small part of the global debt debauch.


Yet the brutal reality, which has been confronted by many developing countries, is that government debt simply has to be eliminated, because the risk of being exposed to the financial Leviathan is too great and certainly outweighs any short term benefits. Australia’s removal of public debt under the Howard government is looking like a very wise strategy; compare it with the profligacy of Britain, for instance. This is the world of the market state. In a sense, governments must learn to hide from the financial markets, and have needed to do that ever since Soros wreaked havoc with the Bank of England. Put another way, if risk analytics are applied to government debt, it is clear that questions have to be asked about whether it is worth it.

The exceptions are large, though. The US, which has the greenback, can run levels of government debt with impunity because there will not be any shortage of demand for T-Bills. It has a free pass because it has the world’s reserve currency (that is why it can run Argentinean levels of debt yet never get punished the way Argentina has been). The other exception is also big: Japan. Because Japan owes all the debt to itself, it also gets an odd type of free pass. It is not exposed to the global capital markets, just to itself.

A report on a talk by Yanis Varoufakis, author of The Global Minotaur,  gives some nice history of how we got here. The Minotaur is a marvelous metaphor for what governments have allowed to occur in the global financial system. Now they, and all of us, are being skewered by its horns:


“In the immediate post-war era, Varoufakis claims, “the Americans begin to take seriously the redemptive mission to save capitalism from itself.”

But in doing so, against its apocalyptic competition with the Soviet Union, America spread itself too thin. Or too thick. By the time it was funding LBJ’s Great Society reform programme, alongside the dire weight of the Vietnam war effort, America stopped being a surplus nation. It went into deficit.

What followed was a worldwide project to balance everyone else’s books in line with the Americans own – what Paul Volcker, American economist and head of the Federal Reserve from 1979-1987, called the “controlled disintegration of the world economy”. Varoufakis compared this to George Osborne’s present fascination with tightening everyone else’s belts. We’re all in it together, but some of us are more all in it together than others.

Thus the Minotaur was both invented, and ultimately, consigned to the Underworld. Around it, “handmaidens” supported the monster – Wall Street (and all that brings to mind), the “toxic politics” of neo-liberalism, and toxic economics, taught in universities across the globe since the advent of Reaganomics and Thatcherism in the West. Varoufakis argued that teaching this bent of economics in our universities is in fact damaging to our understanding of the system. A change is needed, actual as well as intellectual, before we can address our present situation properly.

Towards the end of his speech, Varoufakis claimed: “The Left and Right miss the significance of this current juncture. It is not terminal for capitalism, but it has ended the conglomeration of illusions in how we viewed the world. It ended the illusion we had that we had something called free market capitalism.”