May 19th, 2023 7:00am PDT
(PenniesToSave.com) – Governments frequently rely on borrowing money to finance their projects and services. They accomplish this by issuing debt securities, such as bonds. The funds obtained through these means are then allocated towards essential endeavors like constructing infrastructure, delivering healthcare services, and sustaining social welfare programs.
When a government spends more money than it collects in taxes and other sources of revenue, it creates what is known as a budget deficit. To fill this deficit, the government needs to borrow money. Over time, this can lead to an increasing national debt. The national debt is usually calculated as a percentage of the country’s GDP, which represents the total value of all goods and services produced within the country.
When a country’s national debt exceeds its GDP, this can raise concerns about excessive borrowing and future debt repayment challenges. However, Japan provides an interesting case study as it has managed to maintain stability despite accumulating a massive public debt that is more than double its GDP. This stability can be attributed to confidence in Japan’s economy.
Let’s take a look at the G7, an international economic organization that includes the US, for a country comparison. The US has the largest GDP among the G7 countries, which together account for about half of the world’s wealth. However, some critique the G7 for being perceived as an exclusive economic club.
National debt presents two contrasting scenarios: countries like Germany and Britain have debt levels below 100%, while countries like Italy, the US, and Japan surpass their GDP in debt. Among them, Japan’s debt is especially noteworthy as it has been referred to as a “ticking debt time bomb” by Reuters. The aging population in Japan has led to increased spending on social security without an adequate number of workers to sustain it.
Now, let’s turn our attention back to the United States. While the US debt is not as extreme as Japan’s, it still surpasses the country’s annual output. Debt by itself isn’t an immediate cause for worry as long as creditors can be repaid, which ensures stability and prevents economic issues. However, higher levels of debt result in a substantial portion of annual spending being allocated to interest payments. Despite this, there is currently no imminent risk of a financial collapse.
While there are concerns about various economic indicators, the real threat lies with the US debt ceiling. If the US were to default on its debt payments and fail to pay its creditors, it would severely damage trust in the global financial system. This could lead foreign banks to be hesitant to invest in the US, causing a financial crisis as nations hastily withdraw their investments. The outcome would likely be widespread chaos and instability.
The U.S. does not face significant risk as long as it effectively manages its debt. However, Italy serves as a cautionary example of poor fiscal management despite having a similar debt ratio. Italy’s economy lacks the same level of reliance and trust, leading to sluggish growth and declining living standards caused by their high debt.
Addressing Public Debt
When it comes to managing public debt in major economies, there are typically two main approaches: fiscal discipline and promoting economic growth. Fiscal discipline involves implementing policies that aim to reduce government spending and increase revenue. This can be achieved through measures such as tax increases and budget cuts, often referred to as austerity measures. Take the British government for example, they adopted this strategy beginning in 2010 which led to significant reductions in funding for public services.
On the flip side, economic growth has a crucial role to play. A thriving economy means more government revenue from taxes and other avenues. Additionally, it helps ease the burden of debt by expanding the overall size of the economy compared to the debt. As the economy continues to grow, the debt becomes a smaller proportion of the country’s total economic output.