Brunetti View November 2024

Sovereign debt is incre­a­singly in the spotlight. Find out what this means for the global economy in this exclu­sive assess­ment by our macroe­co­nomic advisor Prof Dr Aymo Brunetti.

published: 05 November 2024

National debt moves into the spotlight

 

Little has changed in the overall economic situa­tion since the last assess­ment six months ago. The industrial sector is still in a prolonged slump in most of the count­ries relevant to Switz­er­land, but services are develo­ping dynamically – well enough to prevent reces­sions in most cases. Germany is still the most troubled of the major European count­ries, with reces­sio­nary trends that have now lasted for quite a long time. The general outlook has not changed signi­fi­cantly either. In its latest forecast from mid-October, the Inter­na­tional Monetary Fund (IMF) expects moderate growth of the global economy in the current and coming year. The obvious discrepancy between sluggish economic develo­p­ment and booming labour markets remains remar­kable. On a positive note, infla­tion has continued to fall in most count­ries and infla­tion rates are falling into areas where it is possible to call it price stabi­lity. The growth forecasts for Switz­er­land in 2025 are slightly higher than for the Eurozone, but still remain below the long-term average.

The economic develo­p­ment in the US raises a few question marks in my assess­ment. At first glance, it looks compa­ra­tively positive. This year and next year, growth is likely to be signi­fi­cantly higher than in the major European count­ries. The infla­tion rate has also fallen signi­fi­cantly from a very high level. However, if you take a closer look, the situa­tion is somewhat less bright. In contrast to most other count­ries, the growth momentum is weake­ning in 2025 compared to 2024 accor­ding to the forecasts. Although core infla­tion (infla­tion of all goods without the parti­cu­larly volatile catego­ries of energy and food) has fallen, it remains well above 3%. This does not suggest that the infla­tion momentum has already been sustain­ably broken. Above all, it is important to bear in mind when asses­sing the US that fiscal policy has been massi­vely more expan­sive in recent years than in the past as well as in compa­rable count­ries. This has probably dampened economic develo­p­ment to such an extent that the compa­ra­tively favourable growth rates need to be put into perspec­tive. In addition, this has led and conti­nues to lead to a long-lasting over-stimu­la­tion of the economy, which is probably the main reason for the conti­nuing high infla­tion dynamics. Above all, however, the ongoing fiscal stimulus is creating massive budget deficits and thus ongoing new debt in the US. And – if the state­ments made by both candi­dates for the presi­dency are to be taken seriously – this unsus­tainable fiscal policy is likely to continue in the coming years. By that point at the latest, the issue of national debt is likely to be at the forefront of global economic risks. We there­fore want to take a closer look at the situa­tion.

 

Global national debt on the rise

Although the US is a parti­cu­larly drastic case in terms of debt dynamics, it is by no means an excep­tion. World­wide public debt has risen dispro­por­tio­na­tely since the Great Finan­cial Crisis. This is illustrated in the chart.

It shows the develo­p­ment of national debt ratios for a selec­tion of important industria­lised count­ries over the last 30 years and the IMF’s forecasts. The effects of the two global economic crises are clearly visible. While debt ratios remained relatively constant until 2008, they began to rise sharply during the Great Finan­cial Crisis. The momentum then eased somewhat before the great pandemic in 2020 caused another jump upwards and pushed the ratios to new record highs. Two count­ries stand out: On the one hand, Italy, which, in contrast to the other count­ries analysed, already had a debt ratio of well over 100% at the begin­ning of the period in 1995. Italy’s debt problems clearly did not arise in the last 30 years, but in the decades before. On the other hand, of course, there is Switz­er­land. At the begin­ning of the period under review, our country had a debt ratio that was roughly at the same level as in the count­ries analysed. From 2005 onwards, however, the dynamics changed comple­tely. In the last appro­xi­m­ately 20 years, Switz­er­land’s debt ratio has been decli­ning.

The finan­cial crisis is not reflected at all in its course and the pandemic only led to a slight increase, which was signi­fi­cantly less prono­unced than in other count­ries. Today, Switz­er­land’s debt ratio is signi­fi­cantly lower than that of compa­rable count­ries. The main reason for this favourable develo­p­ment was the intro­duc­tion of the ‘debt brake’, which forces our country to maintain a balanced budget throug­hout economic cycles. As this stabi­lises debt and GDP conti­nues to grow, the trend in the debt ratio, which we can clearly see in the chart, is downwards.

Illustra­tion: National debts in % of GDP

Source: IMF, Fed

Another striking feature of the chart is the develo­p­ment in the US mentioned above. It has seen the sharpest rise in national debt in recent decades. However, it is the outlook that is most alarming. The chart also contains the forecast of the Inter­na­tional Monetary Fund in dotted lines at the current edge. The US is the only country analysed where an increase is shown for the coming years. Even without the assump­tion of further crises, the US debt ratio conti­nues to grow signi­fi­cantly.

Risks of incre­a­sing debt

There is no scien­ti­fi­cally estab­lished, clearly defined upper limit beyond which a debt ratio would be proble­matic. However, if the ratio rises over a longer period of time, this is usually a sign of unsus­tainable govern­ment finan­cing and indicates the need for reform. This can take a long time and the timing of the correc­tion is diffi­cult to predict. However, the costs of interest service are directly noticeable. If the national debt increases, an incre­a­sing propor­tion of govern­ment revenue has to be used to cover interest payments and is not available for other purposes. The US, for example, has long spent signi­fi­cantly less than 10% of tax revenue on interest payments. If debt conti­nues at the same rate, it will be 20% in ten years’ time and even a third by 2050. This scenario assumes that interest rates remain unchanged. However, the higher the level of debt, the more likely it is that interest rates will start to rise, as debtors will want to be compen­sated for the risk of (partial) payment defaults. If such a process starts, a country can be threa­tened with national bankruptcy in extreme cases.

The US is in the advan­ta­geous position of being able to raise foreign debt in its own currency. It is there­fore likely to take longer for such interest rate premiums to materia­lise. However, if US govern­ment bonds were to lose their role as ‘safe assets’, massive global finan­cial turbu­lence could be expected. It is there­fore reasonable to hope that concerns about the sustaina­bi­lity of govern­ment debt will soon regain the importance they deserve in the economic policy debate in the US. A correc­tion of the current course would be long overdue.

 

Author

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Respon­sible

 

Prof Dr Aymo Brunetti
Econo­mist, Professor of Economic Policy at the Univer­sity of Bern

Sybille Wyss
Chief Execu­tive Officer
s.​wyss@​tareno.​ch

 

Disclaimer

The state­ments and infor­ma­tion in this publi­ca­tion have been compiled by Tareno AG to the best of its knowledge, in part from external (publicly acces­sible) sources which Tareno AG considers to be reliable, for infor­ma­tion purposes only. This publi­ca­tion is not the result of a finan­cial analysis. Tareno AG and its employees are not liable for incor­rect or incom­plete infor­ma­tion or for losses or lost profits resul­ting from the use of infor­ma­tion and the conside­ra­tion of opinions expressed. The state­ments and infor­ma­tion do not consti­tute a solici­ta­tion or invita­tion, offer or recom­men­da­tion to buy or sell any invest­ment instru­ments or to engage in any other transac­tions.

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[Images: Marijke Vosmeer]