Debt: The Options

Debt: The Options

Recently I was talking to a fellow Conservative about debt and he said that Austerity (in Europe) should end as it was killing the economy. I disagreed and to understand why we must look at the options available as well as the consequences.

There are three general options available to Governments when they get themselves into debt and they decide to do something about it.

1. They can honour the debt and pay

2. They can print money and try to devalue the debt using inflation

3. They can repudiate the debt and default

Each has it's own results

1. Paying the debt means financial sacrifice, expenditure must be cut, revenue (meaning tax) should be increased. Maybe worst of all future plans must be curtailed or even scrapped all together. Just to rub salt into the wound it continues for year after year.

2. Another method is to devalue the debt, the current term for it is "Quantitative Easing", it basically means printing more money than the economy needs in an effort to inflate the currency. To make it worth less tomorrow than it was yesterday even though the face value remains the same. If for example the Government owe's $100 million and they inflate the currency and it is now worth $90 million, the Government saved itself $10 million. Here is a trick exclusively available to Governments.

3. Finally they can default on the debt and start with a fresh slate. They can start spending money in a manner that both the Government and the voters find attractive.

Of course each of these in turn has consequences

1. Once a serious effort has been made to pay the debt, the debt will stabilise and then go down. The only time this does not apply is if further increased borrowing occurs. It is slow and painful but it works and allows the Governments credit rating to remain in tack, meaning that further credit will be available if needed at a reasonable price. Regular payments also increase the likely hood that the loan can be renegotiated after all few creditors want to kill the paying customer.

2. Inflation is a tax on the peoples standard of living. It is insidious as it is invisible for along time, but when it hits it hits hard. It hits the poor and those on tight budgets first, whether they be people or businesses. It destroys businesses and drives homebuyer's from their homes. If inflation is 10%, $100 now has the purchasing power of $90. Any money in the bank makes interest and loses it value, all at the same time.

3. Defaulting on the debt seems the best option and it is as long as the Government never wants or needs to borrow money again. The reality is that most Governments borrow money every day, for the simple reason that has bills it simply must pay, every day without fail, payroll, pensions, interest loans are just three of many items. But the bulk of it's revenue doesn't come in every day so to tide themselves over they borrow, just as many businesses do. But once a loan is defaulted you have announced to the world just how bad your financial position is. While they may have thought it was bad the Government has just informed them that it is so bad they have stopped paying their bills. The next question is what other bills will they stop paying?

Pensions!    

Wages!

And why should people continue to pay their debts to the Government (or anyone) when it has stopped paying it's own debt. The idea that the Government starts off with a clean new slate is a mirage, what it ends up with is little credibility and a bad credit rating. As well as a whole series of problems of it's own making.

The bad news is that there is no easy way out of debt. In short debt is bad and only by rejecting debt as an economic policy can this problem be solved.



Upon Hope Blog - A Conservative Future.