The U.S. federal government has been paralyzed for two weeks by a lack of budget spending authority, with hundreds of thousands of federal employees off the job. And that’s been just the immediate economic fallout from the political showdown over allowing the government to borrow beyond its current $16.7-trillion (U.S.) debt ceiling. Without that authorization, many more government operations would cease and the country would likely default on some of its existing debt. Most painful of all, even the best-case outcome appears to be a compromise to permit four months of additional borrowing – merely setting the stage for the next showdown in February.
This latest manifestation of American political dysfunction has roiled the markets for weeks. And they will be roiled again, no doubt, when it happens all over again next year. Counterintuitively, however, financial investors haven’t been losing sleep over debt itself. Neither have economists. Deficits and debt are symptoms of trouble (namely, weak spending power and disappointing job creation), but they’re not the cause. Financial and economic experts grudgingly accept that huge public debts will be part of the economic landscape for years to come. In fact, down on Wall Street they’ve learned to love debt – especially the $85-billion the U.S. Federal Reserve pumps into asset markets every month.
To the contrary, financiers and economists alike were fretting that the United States might suddenly stop borrowing. It’s the potential freezing of debt, not its continued escalation, that’s evoked nightmarish scenarios of financial meltdown and renewed recession. In other words, the problem is not that there’s too much debt – the problem is that debt-phobic politicians, motivated by general ideological suspicion of “big government,” might successfully erect roadblocks to debt’s continued orderly growth.
Worldwide, it’s increasingly clear that it’s misguided efforts to reduce debt that pose the greatest threat to a still-shaky global recovery. In Europe, for example, ultra-orthodox financial bureaucrats at the European Union and the European Central Bank put rapid deficit reduction ahead of growth. But that did far more harm than good; even the International Monetary Fund now acknowledges that massive fiscal cuts have needlessly lengthened Europe’s swoon. So the ECB has changed course and is now facilitating new debt (including by guaranteeing sovereign bonds) – precisely because it’s essential for the recovery.
Meanwhile, Japan’s debt now exceeds 200 per cent of gross domestic product, with nary a whisper of impending doom. Old models that predicted economic disaster as soon as public debt exceeds some arbitrary threshold have been discredited. So long as a country controls its own currency, and so long as spending by businesses, export customers and households is insufficient to absorb economic slack, then increased public debt is not only tolerable – it’s optimal.
The same truth is apparent historically. Canada finished the Second World War with public debt equal to over 150 per cent of GDP. But we never obsessed about “paying off” that debt. Instead, policy-makers unleashed decades of vibrant growth – not by cutting public spending but by increasing it, on things like highways, seaways, medicare and pensions. Thirty years later, the debt was twice as large in absolute dollars – but it had shrunk to a tiny fraction of GDP. Postwar experience proved that it’s far more effective to expand the denominator of the debt-to-GDP ratio, rather than fruitlessly trying to shrink the numerator.
In Canada, we’ve experienced austerity “lite” since the global financial crisis: No historic political showdowns like the United States, no catastrophic cuts like Europe. But we’ve experienced austerity all the same, and the miserly decline in government spending has only undermined our sluggish recovery. Conservative talking points claim that Canada’s fiscal “prudence” has been our ace in the hole. But that argument is based on ideology, not fact. Relaxing our own phony debt “ultimatums” (like the federal government’s promise to balance the books by 2015, and Ontario’s similar pledge to do the same two years later) would allow the public sector to once again contribute to growth, instead of suppressing it.
We should accept the growing international consensus that more public debt is helping the recovery, not hurting it. To paraphrase Franklin Roosevelt, we have nothing to fear from debt – except an ideological fear of debt itself.
Jim Stanford is an economist with the trade union Unifor.
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