Addiction to debt has left the global economy one shock away from disaster

How much debt is too much? After three economic shocks in a row – the financial crisis, the pandemic and the energy price spike – the world economy is drowning in the stuff, with little sign of any life raft to the rescue.

It’s true that, relative to GDP, we’ve seen still higher levels of public debt in the past, the last such occasion as a result of the Second World War. It’s also true that the Japanese economy has managed to coexist with debt to GDP of more than 200pc reasonably well for many years now.

But don’t let these much quoted examples of “debt doesn’t matter” lull you into a false sense of security. High wartime debt was tolerated because everybody knew that military spending would fall significantly the moment the war was over.

What’s more, the post-war years saw an explosion in economic growth, together with the demographic dividend of a baby boom that greatly expanded the size of the workforce.

From the fall of the Berlin Wall onwards, moreover, Western economies enjoyed a pronounced “peace dividend”; defence spending plummeted as a percentage of national income.

No such benign combination of forces is in prospect this time around.

To the contrary, ageing populations threaten only to further dial-up the pressures on public spending. Growing geopolitical instability has meanwhile brought the post-Cold War peace dividend to an end.

As for Japan, there are countervailing factors in play, in particular very high levels of domestic savings and a usually buoyant current account surplus.

Historically, the tax burden in Japan has also been lower than other major high income economies, though it has admittedly crept up in recent years; in any case, there is a sense in which Japan borrows from its citizens rather than taxes them.

Throughout much of the rest of the world economy, we are both taxing more and borrowing more in equal measure. For how much longer can this continue?

There’s a particularly alarming graphic in the International Monetary Fund’s latest “Fiscal Monitor” which shows that, on unchanged policies, federal debt in the United States will soar over the next 30 years to around 160pc of GDP.

It’s even worse for China, where debt is projected to rise to 250pc of GDP. Nor does there seem to be any political appetite for reversing these trends.

If there is one thing that unites both candidates for November’s presidential election in the US, it is a complete disregard for high levels of deficit spending.

China likewise seems hellbent on fiscal oblivion; President Xi Jinping’s need for perpetual growth takes priority over any notion of fiscal discipline.

In both cases, to be running such huge deficits at the top of the cycle, with something close to full employment, is reckless in the extreme.

Unlike much of Europe, America managed to avoid a recession last year. The main explanation is now obvious; like others, deficit spending rose hugely during the pandemic, but unlike others, in the US it has stayed high ever since.

According to IMF estimates, the US ran a fiscal deficit of 8.8pc last year. Under IMF projections, it falls back a tad this year to 6.5pc, but then rises anew next year to 7.1pc, more than three times the average for other advanced economies. Small wonder the US economy is on a tear.

At its spring meeting last month, the IMF uncharacteristically named and shamed four countries that “critically need to take policy action to address fundamental imbalances between spending and revenue”.

Besides the US and China, the other two were the UK and Italy. There are questions to be asked about how it is that France has once again managed to escape the IMF’s strictures, given that its national debt is already quite a bit higher than the UK’s, and its ongoing borrowing needs are also expected to be higher.

Suffice it to say that France has always had the IMF sewn up; even when the managing director is not a French national, the chief economist generally is.

But the wider point about excessive public debt is well made. Stretched fiscal positions in the US, China, France, Italy and the UK have begun to pose a significant threat to the future of the world economy.

Years of money printing and ultra-low interest rates have enabled and normalised previously undreamt levels of indebtedness. But now the props have been kicked away, exposing the risks and associated costs, like a receding tide, in all their gruesome detail.

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