The writer is chief investment officer at BlueBay Asset Management
The coronavirus pandemic has forced countries all over the world to spend money they do not have. Some governments are issuing debt at an astonishing rate. Others, particularly in the developing world, are struggling to keep up with payments on the debt they already have.
In Europe, soaring debt has led some senior Italian officials to ask the European Central Bank to ease debt burdens by forgiving sovereign bonds it owns. That proposal was quickly dismissed by Christine Lagarde and other central bankers and economists.
Their rapid rejection of debt cancellation as part of the recovery from the pandemic misses one very obvious fact. In a world where a lot of sovereign debt is being bought by central banks, intrinsically, all we are doing is allowing the left hand of the government to owe the right hand of the government a lot of money. At some point they could just shake hands and throw the debt away.
Doing so would recognise that central banks effectively have the ability to print money by cancelling government debt. The arrangement sounds potentially toxic but is it? When there is very little inflation, you could probably get away with doing some of this.
Many commentators suggest that quantitative easing is effectively the same as printing money, but this is not the case. In fact, the process of having central banks buy up government bonds for cash is simply the creation of liabilities and the purchasing of assets. The main practical effect is to extend the maturity of debt.
Debt cancellation would be something else entirely, a one-way exchange that is more akin to the unconventional monetary policy idea known as “helicopter money”.
For example, consider what would happen if governments issued 10,000 year bonds at an interest rate of zero and the central banks then bought them up. That is effectively doing the same thing as cancelling the debt.
There is precedent for debt cancellation and not just, I would emphasise, in countries that suffered from hyperinflation such as Zimbabwe or in Germany during the 1930s. There have been cases, such as Canada, which in the late 1930s effectively monetised its debt. This kind of policy shift is something that would need to be eased into.
However, this year has seen the biggest downturn in global economies that any of us have witnessed in our entire lifetimes. Drastic times call for drastic measures and monetary policy is not equipped to deliver what is needed.
Cancelling debt held by central banks does not, on paper, reduce government debt service costs because interest on those bonds is not counted in public sector finances. But it would answer the question about how QE can ever be unwound.
For any country bold enough to consider such extreme action, there may also be a first-mover advantage, because the moment this takes place, borrowing costs should go up. I hasten to add that if a country does go down this route, safeguards are needed. Ideally the government would enshrine in its constitution that this is a one-off emergency response. It cannot continue to print money whenever it wants to do something.
This may sound surprising from someone who invests in debt, but if those safeguards are in place, then maybe debt cancellation is an outcome that we should want to see.
Austerity is not going to be the right answer this time around, indeed if it ever was. It is simply a fancy way of saying that when governments issue debt to address a crisis, their people must pay it back over a long period of higher taxes or reduced spending. That suppresses demand and growth. Even former UK chancellor George Osborne, architect of Britain’s post-2008 austerity measures, has said the UK government may need to write off billions of pounds of loans to small companies to speed the recovery.
Forcing future generations to pay back the debt we are taking on now will become increasingly untenable at a time when populations are ageing and the number of individuals in work is diminishing. It will also create huge pressure within society and greater divisions between old and young, risking a real of loss of social cohesion.
Of course, governments could choose to default on some debt; but this will create enormous damage and cost to the financial system, a very ugly outcome for us all. The Institute for International Finance says debt among advanced nations has soared to 432 per cent of gross domestic product, an unsustainable figure. It is nonsensical to refuse to entertain the prospect of debt cancellation.
When a fixed income asset manager like me is saying there is too much debt in the world, there must be something seriously wrong. Many EU countries have already breached the bloc’s fiscal rules on debt levels and there is little room for manoeuvre. Debt cancellation needs to be an option in the toolkit.
Letters in response to this article:
Pandemic impact boosts case for a debt jubilee / From Claudine Horgan, Director, CJ Horgan & Co, London SW1, UK
How to save the monetary system / From Stephen Butcher, Hambleton, Rutland, UK