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Over-indebtedness in industrialised countries has been exacerbated by the Covid crisis. Guy Wagner, Managing Director of BLI - Banque de Luxembourg Investments, can see no way out other than a return to greater budgetary discipline.

The exceptional crisis we are experiencing has prompted governments to take a number of measures, which have already cost several billion dollars. Could they go further?

How governments finance their spending is a never-ending question. Generally, they have only two options: revenue (mainly taxes) or debt. But unlike ordinary mortals, there are many ways they can increase it. The starting point is to issue debt that is then bought by pension funds and insurance companies.

One can imagine that the prevailing low interest rates are encouraging them to take on debt.

Yes that's true, but it’s dangerous to suggest that everything is possible when interest rates are low. At the moment, the cost of government financing is certainly very low, even negative, and people are increasingly wondering why governments are not taking advantage of this to spend even more.

Responding to both these points: firstly, it is unlikely that interest rates will stay low forever. If we go into debt now and then interest rates rise, the cost of servicing the debt will consume an increasing share of tax revenues. That is dangerous.

Secondly, private savings are not unlimited. The more a government goes into debt, the less money will be available to finance the private sector.

Does that mean that governments don't have much leeway?

Under normal circumstances, their leeway would be unlimited. But the existence of the central banks still has to be taken into account. If, as some people advocate, central banks buy up the debt that governments issue directly, there would, in theory, be no need to call on private savings. But this theory is dangerous, and this mechanism has had disastrous consequences in the past, witness Germany in the 1920s, and later Latin America and Africa.

It is not without good reason that central banks are expected to be independent and have been prohibited from buying public debt directly.

The other role that central banks have played in the last year is to support an expansive monetary policy based on very low interest rates. This has tended to contribute towards the situation we find ourselves in today, rather than solving it.

The global financial system’s big problem is the ever-increasing burden of over-indebtedness. What could be done to get out of this situation?

Unfortunately, there is no miracle solution. One idea has been put forward that may seem interesting on paper: let the central banks assume some of these public debts, then write them off. This may sound like a magic trick, but since central banks also belong to the public sector, such a write-off would be neutral for the private sector, given that the loss would be assumed by the central banks. The only consequence would then be that their capital would become heavily negative – but many would say that this wouldn’t be all that serious.

It looks so simple on paper...

Yes, but it would still be quite difficult to put it into practice, and it could only be done once. So there would have to be real safeguards in place to prevent governments from going back into debt later on. Nothing like this has ever worked to date.

And in any case, why stop there? Why not imagine central banks buying up even more public debt, on the markets, so they could then have even more to write off? But that would not solve the problem of over-indebtedness in the private sector.

The most agreeable way to deal with it is to rely on growth. But since over-indebtedness is a drag on growth, it's a vicious circle.

Does this mean that the sacrosanct convergence and stability criteria of the Maastricht Treaty are now obsolete?

The big difference compared with the last serious economic crisis is that most governments, particularly in Europe, insisted on budgetary rigour at the same time as they were pursuing an extremely expansive monetary policy. Today, this kind of budgetary rigour is beginning to be seen as a negative. People are starting to think the opposite: that with zero or even negative interest rates, not much can be done at a monetary level, and that budgetary and fiscal policy should hold sway and allow governments to spend.

Abandoning budgetary rigour is certainly one of the great lessons to be learned from this situation. But this is very dangerous in the medium term. Guy Wagner, Managing Director, BLI – Banque de Luxembourg Investments

Not to mention the inflationary risk, which is still present...

At least in the medium term, because in the short term the current crisis is rather deflationary. But in the longer term, there are several levels of inflationary risks. The first is the ongoing anti-globalisation movement, with a return to a desire to rely on local production and supply chains. Globalisation had strong deflationary effects; anti-globalisation clearly tends to be more inflationary.

Added to this is the fact that almost unlimited budget spending, financed by what is known as ‘printing money’, also has very inflationary tendencies in the medium term.

What, in the scheme of things, would be the right measures to put in place right now?

It's hard to say! The problem obviously starts with over-indebtedness: currently, the G7 countries have combined public debt representing 140% of their GDP. This is historically high, especially since it does not include expenditure related to demographics and pension systems.

The solution of writing off public debt could only work if it is perfectly orchestrated, but it would require guarantees that such a situation of over-indebtedness would not recur and that governments would henceforth formally commit to respecting budgetary discipline. Given what we’ve seen in the past, it’s hard to be optimistic in this respect. 

Guy Wagner, Managing Director

An economics graduate from the Université Libre de Bruxelles, Guy joined Banque de Luxembourg in 1986 where he was head of the Financial Analysis and Asset Management departments. He was appointed Managing Director of BLI – Banque de Luxembourg Investments in 2005.

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