Investors should weigh hit of high government debt on markets
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After a big decline between February and June, consensus forecasts for global growth have stabilised, recent data suggests. Global equity markets have therefore continued their recovery path, fuelled by central banks lowering rates and the gradual reopening of some economies after lockdowns.
Though the pace of central bank monetary policy easing has stabilised, unprecedented fiscal support and falling government revenues have led to sharply wider fiscal deficits in several economies. The world is now awash with debt issued mainly by governments. It is tempting to believe that these high debt levels are sustainable indefinitely due to the current record low-interest rates.
Like most other economies, SA is expected to accumulate debt at a significant pace over the next 18 months. The debt to GDP ratio is forecast to reach 85% by 2022 — a level last seen in 1935, according to the IMF chartbook. The rise in government debt has been a necessary consequence of Covid-19, but do high government debt levels have an impact on the performance of financial markets? Unfortunately, yes. History tells us that previous waves of rapid debt accumulation have only ever ended in financial crises. Therefore, investors may have to start thinking of ways to insulate their portfolios against such a dreaded outcome.
The general lack of concern is caused by the belief that the authorities can successfully manage excessive government debt levels through innovative policies. In 1947 world-renowned economist Abba Lerner argued that very high government debt does not have to end in default. The interest burden that government incurs can be met by ... printing money. If inflation becomes a problem, the government can raise taxes!
A slightly modified version of this framework is being applied nowadays in modern monetary theory (MMT), which holds that the higher interest burden governments must pay can be met by the central bank significantly reducing interest rates. If investors, or banks, start fearing a government default and this prompts a sell-off of government bonds, the central bank can buy those bonds, thereby maintaining debt service cost at low levels.
Investors and banks will be left holding money instead of government bonds. The theory holds that the newly acquired money will not lead to a rise in inflation because investors will not invest, and banks will not lend into a weak economy. Therefore, without a sharp increase in inflation interest rates can remain lower for longer, and very ...
Though the pace of central bank monetary policy easing has stabilised, unprecedented fiscal support and falling government revenues have led to sharply wider fiscal deficits in several economies. The world is now awash with debt issued mainly by governments. It is tempting to believe that these high debt levels are sustainable indefinitely due to the current record low-interest rates.
Like most other economies, SA is expected to accumulate debt at a significant pace over the next 18 months. The debt to GDP ratio is forecast to reach 85% by 2022 — a level last seen in 1935, according to the IMF chartbook. The rise in government debt has been a necessary consequence of Covid-19, but do high government debt levels have an impact on the performance of financial markets? Unfortunately, yes. History tells us that previous waves of rapid debt accumulation have only ever ended in financial crises. Therefore, investors may have to start thinking of ways to insulate their portfolios against such a dreaded outcome.
The general lack of concern is caused by the belief that the authorities can successfully manage excessive government debt levels through innovative policies. In 1947 world-renowned economist Abba Lerner argued that very high government debt does not have to end in default. The interest burden that government incurs can be met by ... printing money. If inflation becomes a problem, the government can raise taxes!
A slightly modified version of this framework is being applied nowadays in modern monetary theory (MMT), which holds that the higher interest burden governments must pay can be met by the central bank significantly reducing interest rates. If investors, or banks, start fearing a government default and this prompts a sell-off of government bonds, the central bank can buy those bonds, thereby maintaining debt service cost at low levels.
Investors and banks will be left holding money instead of government bonds. The theory holds that the newly acquired money will not lead to a rise in inflation because investors will not invest, and banks will not lend into a weak economy. Therefore, without a sharp increase in inflation interest rates can remain lower for longer, and very ...