The US debt crisis has caught the attention of Elon Musk. He warned that “America is going bankrupt”, after a report showed that 76% of income tax revenues for June were spent on debt repayment. But the US is not alone in having worrying debt levels.
The French elections shone a spotlight on its government debt crisis. The country’s political sclerosis has troubled financial markets, because it makes tackling the vast and burgeoning debt even more difficult. Greece, Italy, France, Spain, Belgium and Portugal all have debt levels of over 100% of GDP.
A recent survey of central bankers by UBS found that the level of global government debt was their fastest-growing concern. Some 37% of central bank managers said global sovereign debt levels were among their main worries for the global economy in the year ahead. This was an increase from just 14% who were troubled about the same issue last year.
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The Institute of International Finance says that global government debt is now over $90trn though more than a third of this ($34trn) is attributable to the US. In aggregate, global debt as a percentage of GDP is likely to tip back over 100% this year. Governments have struggled to normalise spending after the pandemic.
Central bankers are not the first to raise the alarm. In June, the IMF urged the US to address its mounting government deficit, criticising both presidential candidates’ fiscal plans and warning that the country faced higher financing costs.
It said: “The fiscal deficit is too large, creating a sustained upward trajectory for the public debt-GDP ratio. The ongoing expansion of trade restrictions and insufficient progress in addressing the vulnerabilities highlighted by the 2023 bank failures both pose important downside risks.
“Under current policies, the general government debt is expected to rise steadily and exceed 140% of GDP by 2032. Similarly, the general government deficit is expected to remain around 2½% of GDP above the levels forecast at the time of the 2019 Article IV consultation. Such high deficits and debt create a growing risk to the US and global economy, potentially feeding into higher fiscal financing costs and a growing risk to the smooth rollover of maturing obligations.”
Manageable?
That said, there are those who believe deficits are, for the most part, still manageable. It is also worth noting that government debt is not central bankers’ greatest concern: they are more worried about geopolitical conflicts, persistent inflation and an uncontrolled rise in long-term yields.
Oxford Economics says: “Key risks to fiscal sustainability include rising debt servicing costs, aging populations with related social spending, geopolitical risks and associated defence spending, and climate-related greening investment. All of these risks are currently manageable.
“Higher debt servicing costs are not critically threatening even if higher inflation leads to higher-for-longer policy rates as it would also mean higher fiscal revenues. Although defence spending is likely to rise from here, it is still a relatively low budget item (around 1% of GDP in most European economies) and therefore is unlikely to cause disruptions. Climate spending too is relatively low, though it already exceeds previously established targets in most advanced economies.”
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It believes European countries could reduce debt without major fiscal changes. However, it believes the US may have problems ahead. It is currently running with debt at 122% of GDP and will need significant policy adjustments to stabilise its growing debt levels. Oxford Economics believes political changes might shift the short-term debt trajectory, but will not change the overall sustainability as it stands.
There are also more encouraging signs ahead. Growth is improving across much of Europe, including previous laggards such as the UK. This may incrementally start to improve the debt problem. Falling interest rates may also improve the sustainability of debt levels.
Political instability
Even if European debt is – largely – sustainable at current levels, it makes fragile politics a greater risk. A wayward populist government could destabilise countries’ fragile fiscal balance. Oxford Economics adds: “Even in countries where current debt paths don’t call for significant cost cuts, the question remains whether current spending plans might in unfavourable scenarios jeopardise debt sustainability.”
This circles back to the problem in France. Frédérique Carrier, head of investment strategy for RBC Wealth Management in the British Isles and Asia, says: “Markets worry that the National Rally’s expansive fiscal policy at a time when the country’s fiscal deficit exceeds 5% could destabilise the region, much like Greece did in 2012. This would be problematic as France is the second-largest economy in the eurozone. Ultimately, we believe that if the RN becomes part of the government, it would likely align itself with Brussels’ fiscal policies. It would not be in the RN’s best interest to upset the apple cart ahead of the French presidential elections in 2027, in our view.”
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Jim Cielinski, global head of fixed income at Janus Henderson Investors, says the US election could bring the US debt problem to the fore. “This could shine a spotlight on government debt levels and fiscal profligacy…It could also reawaken concerns around protectionism and tariffs on trade, given that easing of supply chain bottlenecks has been instrumental in helping to bring down inflation from its post-Covid highs.”
While global debt levels appear sustainable for the time being, they remain vulnerable to poor political management and – in particular – populist governments with little inclination to fiscal responsibility. The situation in France may be a trial run for an even bigger problem in the US later this year.
