Concepts From Japan

Government debt to GDP is a tricky subject to discuss these days, largely because Japan with its extreme, and growing, debt loads kind of broke a lot of people's (including mine) intuitions about debt.  The lunatic fringe of economics (MMT) likes to nod toward Japan as an example of how debt doesn't matter as long as you can print your own currency, but they don't want to nod to much as it brings up the obvious questions about their growth and how, just perhaps, avoiding collapse isn't a good enough metric on its own.  Monetarists were really excited about Japan for about a quarter or two when they promised really hard to raise inflation, and managed to do it (with a large tax increase) for brief period, and Keynesians had to repeat the adage of "they didn't stimulate enough" so many times even they appear tired of it. 

Japan is a great example of one major impact of high debt loads, you get boxed in on one path, or boxed out of others.  The old debt concept that since a government liability is someone else's asset they must cancel out only works on the balance sheet.  With a debt to GDP ratio of 250% these days and government spending at around 40% of GDP interest rates of 16% would engulf the entire budget.  This is an extreme and ultimately meaningless example in a lot of ways, interest rates are no where near 16%, Japan doesn't roll over its bonds annually, etc.  The idea is not to note THE point where their government would 100% go bankrupt, but to note how much lower the point is now than it was 10, 20 and 25 years ago.  In 2008 debt to GDP was around 190%, and a (potential) budget of 40% of GDP meant that Japan could not pay more than a 21% interest rate, and in 1996/97 when it was 100% it was a 40% rate, and their pre debt explosion levels it would have been between 55 and 60%. 

In less than 30 years Japan has gone from definite ruin at levels rarely seen (only under hyperinflation) only under to levels seen in the 1970s into the early 1980s in many countries.   It is of course unlikely that they would stave off ruin until these levels were hit, interest rates of even 5 percent now across all of their debt would be very difficult to handle and would mean effectively shifting about 10% of GDP worth of spending away from current programs to interest payments, which would have a lot of impact across the economy. 

So does high debt cause low growth or does low growth cause the high debt?  The obvious answer is yes.  Both occur.  Once high debt is in place it is very difficult to get high growth, even if you have long dated bonds where the government will have years of cushion to reduce debt levels before the payments become a problem the bondholders will be taking real losses.  If those bonds are held by citizens and corporations then those losses should be a real drag on the economy.  If interest rates tracked growth perfectly (they don't, but its a starting point) then debt levels 100% of GDP would mean functionally all increases in growth would be offset by decreases in wealth held by the public.  The reverse, perversely, might be true as well.  Declining growth would mean declining interest rates, which would push the value of debt up as long as it wasn't perceived to increase the likelihood of default. 

Why do I say perversely above?  Aren't these stabilizing forces?  I don't think that they are, I see them as channeling forces, as the economy can't handle anything outside the norm well, be it growth or contraction, and so the potential pathway of the economy narrows effectively removing the dynamic segments of the markets. 

Some countries have managed to reduce large debt loads while breaking out of a potential channel, the US after WW2 is one good example, but if you look at what it took overall it is daunting.  Federal spending was slashed by 40% in year 1 after the war, then another 40% in year 2 and another 10% in year 3, the economy was effectively heavily liberalized as inhibiting regulations (price controls and the like) were removed and perpetual destruction of capital in the form of war losses were cut out, and the Federal Reserve did its bit to, keeping rates low for years after the war (and possibly causing the stagflation of the 70s along the way... possibly).

Greece is a good (as in terrible) example of how badly this type of channeling can go, the government got to a point where outside funding was necessary very early on which allowed the scenario where those outside forces could dictate Greek policy.  Now the Greeks weren't doing a bang up job managing themselves but this functionally cut out some of the possible routes out of the crisis.  A dedicated public servant pitching a plan to restore economic growth had a double hurdle to overcome, convincing both the public of his plan and external lenders.  There is a general truism here, the fewer options you have the more likely that all of them are going to be bad.