Covid-19: The growing post-peak debt will be a burden for decades

The Coronavirus has been a huge financial burden on governments, institutions, companies and individuals. The cost of lockdown and the economy grinding to a halt has been huge. Many companies have furloughed staff, made people redundant or cut salaries. This all means there is less money floating around the economy to spend on goods and services which has a further downwards pressure on the economy.

Unemployment in the US rose by 10 million Americans in the last two weeks of March according to CNN which equates to about 6% of the labour force losing their jobs. Meanwhile, in Europe, the unemployment impact has been much less as governments subsidise job retention schemes trying to keep businesses going.

Either way, there is a huge knock-on social welfare costs that government need to pick up and this is all at a time when the governments will receive less money from taxation. Not only this, but there will also be increased pressure on governments to provide more medical services and protection for the vulnerable and elderly.

So what do governments do in these situations where they need more money? They borrow.

Governments routinely borrow whenever they have a budget deficit by issuing government securities.

In the US, where the government has put a $2 trillion dollar package in place, the traditional relationship between the Fed and the government has been abandoned which has allowed money to be created out of thin air by buying its own debt.

In the UK that government release gilts and bills that are bought up by investors such as insurance and pension companies who see these are low-risk investments. When these debts are due to be paid back the government just issue more gilts and bills to cover the payback so the debt stacks up over time. However, there are signs that the appetite to buy government securities is low and as such the Monetary Policy Committee are talking about buying government bonds directly from the treasury. This then becomes similar to the US, making money out of thin air. Or in older terminology, it is akin to printing money.

All of this is very likely to lead to inflation as more money in circulation in an economy reduces its value. A little bit of inflation is probably not a bad thing as it decreases the debt burden over time. For example, imagine with inflation, prices go up and wages must go up to maintain a standard of living, but your mortgage debt has stayed the same. In real terms, therefore, you have less to pay back and your debt burden is reduced. This plays out in a similar way across the economy.

Inflation will put pressure on the standard of living of nominal wages do not increase at the same rate. In a high inflation situation, consumers may also rush to make purchases with the fear that the prices are going to go up. Governments will be tempted to increase interest rates to control inflation but this will put pressure on the debt burden.

In the short term, the governments have no alternative but to borrow to pay their way through this situation and to keep their citizens as safe as possible. They also need to stimulate growth as we come through the peak and fire up our economies again. In the longer term, late in the decade and the decades to come, the government will need to balance their budgets very carefully and it is going to present a difficult situation for many governments. Many European countries have had years of austerity just to get past the effects of the last financial crisis and this is much bigger.

After the second world war, many countries had huge debt from financing the war. They were, however, living in prosperous times. There was a baby boom and huge advances in technology that allowed countries to grow their way out of much of their national debt. Perhaps what we need now is a communal positive spirit to work hard and grow our way out of this too. Everyone will need to pull together for the long haul.