The world is sitting on a $91 trillion problem. ‘Hard choices’ are coming

Analysis by Hanna Ziady, CNN

London (CNN) — Governments owe an unprecedented $91 trillion, an amount almost equal to the size of the global economy and one that will ultimately exact a heavy toll on their populations.

Debt burdens have grown so large — in part because of the cost of the pandemic — that they now pose a growing threat to living standards even in rich economies, including the United States.

Yet, in a year of elections around the world, politicians are largely ignoring the problem, unwilling to level with voters about the tax increases and spending cuts needed to tackle the deluge of borrowing. In some cases, they’re even making profligate promises that could at the very least jack up inflation again and could even trigger a new financial crisis.

The International Monetary Fund last week reiterated its warning that “chronic fiscal deficits” in the US must be “urgently addressed.” Investors have long shared that disquiet about the long-term trajectory of the US government’s finances.

“(But) continuing deficits and a rising debt burden have (now) made that more of a medium-term concern,” Roger Hallam, global head of rates at Vanguard, one of the world’s largest asset managers, told CNN.

As debt burdens mount around the world, investors are growing anxious. In France, political turmoil has exacerbated concerns about the country’s debt, sending bond yields, or returns demanded by investors, soaring.

The first round of snap elections Sunday suggested that some of the market’s worst fears might not come to pass. But even without the specter of an immediate financial crisis, investors are demanding higher yields to buy the debt of many governments as shortfalls between spending and taxes balloon.

Higher debt servicing costs mean less money available for crucial public services or for responding to crises such as financial meltdowns, pandemics or wars.

Since government bond yields are used to price other debt, such as mortgages, rising yields also mean higher borrowing costs for households and businesses, which hurt economic growth.

As interest rates rise, private investment falls and governments are less able to borrow to respond to economic downturns.

Tackling America’s debt problem will require either tax hikes or cuts to benefits, such as social security and health insurance programs, said Karen Dynan, former chief economist at the US Treasury and now professor at the Harvard Kennedy School. “Many (politicians) are not willing to talk about the hard choices that are going to need to be made. These are very serious decisions… and they could be very consequential for people’s lives.”

Kenneth Rogoff, an economics professor at Harvard University, agrees that the US and other countries will have to make painful adjustments.

Debt is “not free anymore,” he told CNN.

“In the 2010s, a lot of academics, policymakers and central bankers came to the view that interest rates were just going to be near zero forever and then they started thinking debt was a free lunch,” he said.

“That was always wrong-headed because you can think of government debt as holding a flexible-rate mortgage and, if the interest rates go up sharply, your interest payments go up a lot. And that’s exactly what’s happened all over the world.”

‘Conspiracy of silence’

In the United States, the federal government will spend $892 billion in the current fiscal year on interest payments — more than it has earmarked for defense and approaching the budget for Medicare, health insurance for older people and those with disabilities.

Next year, interest payments will top $1 trillion on national debt of more than $30 trillion, itself a sum roughly equal to the size of the US economy, according to the Congressional Budget Office, Congress’s fiscal watchdog.

The CBO sees US debt reaching 122% of GDP a mere 10 years from now. And in 2054, debt is forecast to hit 166% of GDP, slowing economic growth.

So how much debt is too much? Economists don’t think there is a “predetermined level at which bad things happen in markets,” but most reckon that if debt hits 150% or 180% of gross domestic product, that means “very serious costs for the economy and society more broadly,” said Dynan.

Despite growing alarm over the federal government’s debt pile, neither Joe Biden nor Donald Trump, the main 2024 presidential candidates, are promising fiscal discipline ahead of the election.

During the first televised presidential debate last week, hosted by CNN, each candidate accused the other of making America’s debt situation worse, either through tax cuts by Trump or additional spending by Biden.

British politicians have also buried their heads in the sand ahead of a general election Thursday. The Institute for Fiscal Studies, an influential think tank, has decried a “conspiracy of silence” between the country’s two main political parties, over the poor state of public finances.

“Regardless of who takes office following the general election, they will — unless they get lucky — soon face a stark choice,” IFS director Paul Johnson said last week. “Raise taxes by more than they have told us in their manifestos, or implement cuts to some areas of spending, or borrow more and be content for debt to rise for longer.”

Countries trying to tackle the debt issue are struggling. In Germany, ongoing infighting over debt limits has put the country’s three-way governing coalition under enormous strain. The political standoff could come to a head this month.

In Kenya, blowback over attempts to address the country’s $80 billion debt burden has been much worse. Proposed tax hikes have sparked nationwide protests, which have claimed 39 lives, prompting President William Ruto to announce last week that he would not sign the proposals into law.

Enter the scary bond market

But the problem with putting off efforts to rein in debt is that it leaves governments vulnerable to far more painful disciplining by financial markets. The United Kingdom offers the most recent example in a major economy. Former Prime Minister Liz Truss triggered a collapse in the pound in 2022 when she tried to force through big tax cuts funded by increased borrowing.

And the threat hasn’t gone away. Take France. The risk of a financial crisis there became a serious concern virtually overnight after President Emmanuel Macron called a snap election last month.

Investors were worried voters would elect a parliament of populists bent on spending more and cutting taxes, further swelling the country’s already-high debt and budget deficit.

Even though this worst-case scenario now looks less likely, what happens after next Sunday’s second round of voting is far from certain. Yields on French government bonds have continued creeping up, reaching their highest level in eight months Tuesday.

Dynan at the Harvard Kennedy School says financial markets can quickly become unnerved by “political dysfunction” that causes investors to doubt a government’s willingness to make good on its debt.

“We tend to have a lack of imagination about the scope for things going wrong. If there’s a big event in which the market freaks out about (US) debt, it’s not going to be something that was on our radar,” she said.

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