Stephen King: Hard times... Prepare yourself for the worst, our debt is here to stay

Economic Outlook: High government debt does not have to threaten the fabric of economic life

We are not where we were supposed to be. The financial crisis led both to economic collapse and to an absence of healthy recovery thereafter. Levels of economic activity are much lower than expected. It's a struggle to make the budgetary arithmetic add up – whether for households or, increasingly nowadays, for governments. And we haven't yet come to terms with this new – and painful – economic reality.

We continue to live in hope, seizing upon the occasional piece of economic data offering some upside surprise. Last Friday, we discovered that the US economy had created 200,000 new jobs at the end of last year– a gain modestly ahead of market expectations – and that the unemployment rate had dropped to 8.5 per cent. All good news, of course but, frankly, not good enough. In previous economic upswings, the US had no difficulty in creating 300,000 to 400,000 jobs per month.

Hope is not the same thing as good policy. We have been living in hope for too long, yet our hopes are not being met. Government budgetary positions are in danger of spiralling out of control. Investors are already well aware of the fiscal risks in southern Europe: bond yields in Italy and Spain are painfully high, while the Greek government debt market has gone beyond the point of no return. Fiscal risks are not, however, confined to the eurozone.

The US and the UK have the advantage of seeing their central banks manning the printing press: the newly created money is used to buy government bonds, thus keeping yields lower than they might otherwise be. It's a useful wheeze in the short term, but it's not clear it can continue indefinitely: too much money chasing too few goods doesn't sound like a recipe for success, particularly if the low level of yields allows governments to delay and defer ultimately necessary fiscal retrenchment. And, in the event of another recession – leading to yet another shortfall of tax revenue – US and UK government debt could spiral out of control even with quantitative easing.

The broad sweep of history demonstrates all too clearly that government debt in the western world has reached levels relative to income impossible to sustain over the medium term. The Liquidation of Government Debt, an important paper written last year by Carmen Reinhart and Belen Sbrancia, shows that there have been only a handful of occasions over the last century when government debt as a share of GDP reached levels even close to where we are today: after the First World War, through the Depression years and immediately following the Second World War. In each of these cases, government debt eventually came back down, at least as a share of income. The key question is: how?

There is no reason to think that high levels of government debt necessarily threaten the fabric of economic life. After all, the 25 years following the end of the Second World War saw rapid economic expansion accompanied by very low interest rates and sustained reduction of government debt. This was a period now frequently labelled as "financial repression". Interest rates were kept artificially low, capital and exchange controls were used to prevent funds from heading abroad, and banks constantly had to cope with the vagaries of changes in reserve requirements and other "macro-prudential" policies. Meanwhile, although inflation was hardly running out of control, it was high enough to ensure that interest rates were often negative in "real", inflation-adjusted, terms, ensuring that savers (as opposed to debtors, including governments) ended up with pathetically low returns.

Those who wish for renewed financial stability are often, at least implicitly, demanding a return to these kinds of conditions. And if growth at the time was so good, is it such an unreasonable ambition?

In truth, there are objections aplenty. Not least, we no longer live in a world of cross-border capital controls. It's difficult to see, in the West at least, any enthusiasm for their return. It's not just the inevitable opposition from multinationals: we have all, whether we like it or not, become a lot more cosmopolitan, no longer regarding national borders as a barrier to either business or pleasure. Yet, with the return of capital controls, national borders would suddenly become a lot more relevant again: not so much an iron curtain as a regulatory force field preventing international economic relationships from being sustained.

Growth in the 1950s and 1960s was strong arguably in spite of – and not because of – financial repression. Through successive GATT (General Agreement on Tariffs and Trade) rounds, trade barriers came down rapidly, providing a massive stimulus to world trade growth. And the 1950s were, of course, the decade of post-war reconstruction, involving huge international government transfers linked, most obviously, to the Marshall Plan. Those transfers wouldn't have happened had the Americans not been so exercised about the spread of Soviet Communism throughout Europe.

Put another way, growth in the 1950s and 1960s owed a lot to unrepeatable one-offs which simply cannot play any kind of role today. Financial repression now is, thus, much more worrisome, as anyone in the UK will know, having compared the low level of interest rates with what has proved to be a stubbornly high rate of inflation.

But is financial repression enough to solve government debt difficulties? In the absence of a return to 1950s and 1960s-style economic growth, would a combination of low interest rates, higher inflation and increased private sector holdings of government bonds (for "macroprudential" reasons) be enough to bring government debt as a share of income back down again? It seems unlikely.

That leaves us with a number of awkward options. After the First World War, some heavily indebted countries – most obviously Germany – succumbed to hyper-inflation. During the 1930s, many countries were forced to default through one means or another. Today, devaluation offers a useful escape route for those nations who've borrowed heavily in their own currency from others (the US and, to a lesser extent, the UK fit into this category). And then there's the austerity option, which imposes a huge burden on the current debtor population, allowing the (typically foreign) creditor to be absolved of both blame and pain.

All of the above would help deal with high levels of government debt, but none is palatable. Yet unless there is a decisive shift in government debt dynamics, history suggests we should prepare ourselves for the worst.

The obvious means of escape – as we saw in the 1950s and 1960s – is to find another source of economic growth. That means fostering closer linkages with the faster-growing emerging nations, keeping global trade routes open, pursuing productivity gains wherever they can be found and accepting that, without hard work (and that includes raising retirement ages), we'll be faced with hard times. Hope alone will not triumph over painful experience.

Sport
Mourinho lost his temper as well as the match
sportLiverpool handed title boost as Sunderland smash manager’s 77-game home league run
Voices
Sweet tweet: Victoria Beckham’s selfie, taken on her 40th birthday on Thursday
voices... and her career-long attack on the absurd criteria by which we define our 'betters', by Ellen E Jones
Arts & Entertainment
Billie Jean King, who won the women’s Wimbledon title in 1967, when the first colour pictures were broadcast
tv
News
Snow has no plans to step back or reduce his workload
mediaIt's 25 years since Jon Snow first presented Channel 4 News, and his drive shows no sign of diminishing
VIDEO
Life & Style
food + drinkWhat’s not to like?
Voices
Clock off: France has had a 35‑hour working week since 1999
voicesThere's no truth to a law banning work emails after 6pm, but that didn’t stop media hysteria
Arts & Entertainment
Maisie Williams of Game of Thrones now
tvMajor roles that grow with their child actors are helping them to steal the show on TV
Life & Style
Lana Del Rey, Alexa Chung and Cara Delevingne each carry their signature bag
fashionMulberry's decision to go for the super-rich backfired dramatically
Arts & Entertainment
Kingdom Tower
architecture
Life & Style
Sampling wine in Turin
food + drink...and abstaining may be worse than drinking too much, says scientist
Arts & Entertainment
Game of Thrones writer George R.R. Martin has been working on the novels since the mid-Nineties
books
News
Easter a dangerous time for dogs
these are the new ones. Old ones are below them... news
News
Brand said he
people
Voices
Actor Zac Efron
voicesTopless men? It's as bad as Page 3, says Howard Jacobson
Sport
Roger Federer celebrates his victory over Novak Djokovic in the Monte Carlo Masters
sport
Arts & Entertainment
The monster rears its head as it roars into the sky
film
Voices
For the Love of God (2007) The diamond-encrusted skull that divided the art world failed to sell for
its $100m asking price. It was eventually bought by a consortium
which included the artist himself.
voicesYou can shove it, Mr Webb – I'll be having fun until the day I die, says Janet Street-Porter
Have you tried new the Independent Digital Edition iPad app?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

1st Line Helpdesk Engineer Apprentice

£150.00 per week: QA Apprenticeships: This company has been providing on site ...

Telesales & Sales Support Apprentice

£221.25 per week: QA Apprenticeships: This company is a well established Inter...

Client Relationship Manager - SQL, Python

£40000 - £50000 per annum: Harrington Starr: Client Relationship Manager - SQL...

**Financial Services Tax**

£35000 - £50000 per annum: Pro-Recruitment Group: Take your chance to join the...

Day In a Page

How I brokered a peace deal with Robert Mugabe: Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC

How I brokered a peace deal with Robert Mugabe

Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC
Video of British Muslims dancing to Pharrell Williams's hit Happy attacked as 'sinful'

British Muslims's Happy video attacked as 'sinful'

The four-minute clip by Honesty Policy has had more than 300,000 hits on YouTube
Church of England-raised Michael Williams describes the unexpected joys in learning about his family's Jewish faith

Michael Williams: Do as I do, not as I pray

Church of England-raised Williams describes the unexpected joys in learning about his family's Jewish faith
A History of the First World War in 100 moments: A visit to the Front Line by the Prime Minister's wife

A History of the First World War in 100 moments

A visit to the Front Line by the Prime Minister's wife
Comedian Jenny Collier: 'Sexism I experienced on stand-up circuit should be extinct'

Jenny Collier: 'Sexism on stand-up circuit should be extinct'

The comedian's appearance at a show on the eve of International Women's Day was cancelled because they had "too many women" on the bill
Cannes Film Festival: Ken Loach and Mike Leigh to fight it out for the Palme d'Or

Cannes Film Festival

Ken Loach and Mike Leigh to fight it out for the Palme d'Or
The concept album makes surprise top ten return with neolithic opus from Jethro Tull's Ian Anderson

The concept album makes surprise top ten return

Neolithic opus from Jethro Tull's Ian Anderson is unexpected success
Lichen is the surprise new ingredient on fine-dining menus, thanks to our love of Scandinavian and Indian cuisines

Lichen is surprise new ingredient on fine-dining menus

Emily Jupp discovers how it can give a unique, smoky flavour to our cooking
10 best baking books

10 best baking books

Planning a spot of baking this bank holiday weekend? From old favourites to new releases, here’s ten cookbooks for you
Jury still out on Manchester City boss Manuel Pellegrini

Jury still out on Pellegrini

Draw with Sunderland raises questions over Manchester City manager's ability to motivate and unify his players
Ben Stokes: 'Punching lockers isn't way forward'

Ben Stokes: 'Punching lockers isn't way forward'

The all-rounder has been hailed as future star after Ashes debut but incident in Caribbean added to doubts about discipline. Jon Culley meets a man looking to control his emotions
Mark Johnston: First £1 million jackpot spurs him on

Mark Johnston: First £1 million jackpot spurs him on

The most prize money ever at an All-Weather race day is up for grabs at Lingfield on Friday, and the record-breaking trainer tells Jon Freeman how times have changed
Ricky Gervais: 'People are waiting for me to fail. If you think it's awful, then just don't watch it'

Ricky Gervais: 'People are waiting for me to fail'

As the second series of his divisive sitcom 'Derek' hits screens, the comedian tells James Rampton why he'll never bow to the critics who habitually circle his work
Mad Men series 7, TV review: The suits are still sharp, but Don Draper has lost his edge

Mad Men returns for a final fling

The suits are still sharp, but Don Draper has lost his edge
Google finds a lift into space will never get off the ground as there is no material strong enough for a cable from Earth into orbit

Google finds a lift into space will never get off the ground

Technology giant’s scientists say there is no material strong enough for a cable from Earth into orbit