This week, my attention was drawn to the publication of the latest report by the French National Institute of Statistics and Economic Studies (INSEE), which revealed that the government’s public deficit reached 5.5% of GDP in 2023, far from the 3% limit that France, like other eurozone countries, committed not to exceed under the Maastricht Treaty. This publication echoed in my mind articles published last month in the American press, which reported that the US debt was increasing by $1 trillion per… month (yes, you read that right). More broadly, more and more voices are being raised to sound the alarm about the rise of public deficits and the impact that uncontrolled deficits can have on our daily lives. This is the subject of this week’s post.
First, a small terminological clarification. The public surplus or deficit measures the difference between a state’s income and expenditures over a given period, usually one year. It is, therefore, a flow. These accumulated surpluses or deficits contribute to the stock of debt.
Let’s look at the data. Taking the American situation as an example, we notice that the federal government has almost always spent more than it has received. The last annual surplus was recorded in… 2001, and in 2023 the American deficit reached 6.1% of GDP (not so far from the French situation, after all). It can be noted that deficits tend to significantly deepen during periods of economic recession (marked in gray on the graph below).
These successive deficits have contributed to the swelling of the debt stock, which went from about 30% of GDP in the early 1980s to 120% today. The impact of the last two major financial crises is quite clearly visible on the graph below. The subprime crisis of 2008-2009 was, to a large extent, absorbed by the intervention of the American Treasury, which purchased a large quantity of poor-quality debt held by banks. The COVID crisis, in 2020, explains the most recent surge.
This explosion of debt, common to the vast majority of developed economies, was long considered a benign issue, due to the ultra-accommodating policy of central banks. Indeed, even if states had to borrow (and thus pay interest) on huge amounts of debt, the rates practiced, barely above 0%, or even negative in some cases, allowed them to postpone the problem of repayment painlessly. When a debt security matured, the state simply issued a new one and used the money from one to repay the other.
The situation changed since 2022. Under the pressure of inflation, a subject already widely covered on this blog, central banks were led to act and to drastically increase reference interest rates. No more free debt, now interest must be paid! And structural deficits are not absorbed. States thus find themselves mired in a vicious circle, which can be summarized as below.
This change in trend has not gone unnoticed by rating agencies, whose role is to estimate the risk of default of companies or states that issue debt securities. Previously, debt issued by economically powerful states appeared safe and enjoyed excellent ratings. Now, downgrades are multiplying and sparing no one, neither the United States nor France, for example. Like a household, if a state appears less “safe,” lenders will demand a higher interest rate to cover against the risk of default, making the situation of public finances even more precarious.
These cumulative phenomena make the situation of states perilous. In 2014, the United States devoted 1.3% of their GDP to the repayment of interest on their debt. In 2023, this ratio reached 2.4% and is expected to continue to rise in the near future, as old debt securities, contracted at low interest rates, continue to be replaced by securities with higher interest rates.
It is indeed the inertia of the phenomenon that worries. Current governments seem to inherit a past situation and possess only very limited control over it. Unfortunately, this fear seems well-founded. Rectifying public finances in a complicated context like the one we are going through today is an exercise all the more difficult as we did not manage to do so when the economic context was more favorable. Rather than thinking like a household, which saves in times of plenty to face lean periods, states have constantly lived beyond their means and will have to face the consequences.
What consequences can we actually imagine? In the short term, states seem trapped by the debt trap, forced to issue more debt securities, and thus currency, to meet their growing obligations. However, this phenomenon will continue to grow the stock of debt in the short term, and monetary creation will tend to stimulate inflation. To regain control, like any company, states will need to increase revenues and/or decrease expenditures. Revenues come from taxes, the amount of which depends on economic activity and the tax rate. At least one of these must increase, and the state has direct control only over the latter. In the absence of an increase in tax revenues, the state has no choice but to cut costs.
For a practical application, the Argentine situation, although extreme, can provide some elements for reflection. To fight against hyperinflation (prices tripled in 2023), and under the impulse of the IMF (whose policy would deserve a post of its own, the Greeks will certainly not contradict me on this), the new President Milei made “0 public deficit” a priority, deciding on a severe austerity cure, drastically cutting public spending, and also devaluing the local currency to give competitiveness back to its businesses. As a result, the Argentine state generated fiscal surpluses in January and February 2024, but at the cost of significant social and economic damage: massive price increases due to the disappearance of generous state subsidies, the disappearance of tens of thousands of public sector jobs, reduction in the amount of pensions and salaries, etc.
It’s not certain that other governments will have to employ measures as drastic. However, this illustration shows that the issue of debt management, like that of demography, is akin to piloting an ocean liner. Any change of course must be anticipated and planned. Otherwise, desperate steering moves are painful – and will not avoid hitting the “debt wall.”