With government debt soaring worldwide this year, what are the implications for savers and investors in the post-virus world? The global economic shutdown ordered to reduce transmission of the COVID-19 virus has dramatically reduced tax revenue. Meanwhile, government stimulus to support businesses and workers has reached unprecedented levels. A logical question is "how will governments pay off their debts?"
Keith Wade, chief economist at Schroders, believes "It is increasingly likely that governments will rely on 'financial repression' to erode their debt-to-income ratios". This means governments will artificially reduce interest rates to keep their borrowing costs low.
According to a 2015 paper by economists Carmen Reinhart and M. Belen Sbracia, twelve countries used financial repression between 1945 and 1980 to lower interest rates by 1% to 5% per year and "played an instrumental role in reducing or liquidating the massive… debt accumulated during World War II."
Alternative strategies might include accelerating economic growth to boost tax revenue, but this would be particularly challenging for economies with slowly growing populations and modest productivity gains. Another approach would be to encourage higher inflation, which would allow today's debt to be paid down with cheaper money in the future. Boosting inflation, however, introduces too many uncertainties and is harder to manage.
Traditional measures of "austerity" like spending cuts and tax increases could be used. But this approach is never popular with voters and could jeopardize reelection efforts by those in power. "If the austerity debate continues to be as poisonous as it is now, the way to pay down debt may be through financial repression," said Ricardo Reis, an economist at the London School of Economics.
Of course, every strategy has consequences that will burden some people more than others. The costs of austerity measures largely fall on lower-income households through reduced government spending. Driving inflation higher would favor debtors over lenders. Meanwhile, suppressing interest rates under financial repression can prompt savers to look for higher returns from riskier investments.
Whatever strategy the U.S. government pursues to manage its extraordinary debt load, navigating the post-virus era in search of opportunity will require balance and perspective. And that is why you have me, a veteran financial advisor-- to help!
The views expressed are those of Lindsey Randolph and should not be construed as investment advice. All economic information is historical and not indicative of future results. All information is believed to be from reliable sources; however, we make no representations as to its completeness or accuracy. Discuss all information with your advisor prior to implementation.