Treasury bond and economic growth

Let's talk about Treasury bonds, an attractive but complicated topic in the financial world. Although this topic may be a bit complex, I will try to explain it to you in a simple and understandable way. In the past 25 years, the ratio of the US Treasury bond to gross domestic product (GDP) has been soaring, almost more than 12%. The UK, the euro area, and China are also increasing national government debt at a seemingly incredible rate. The most exaggerated is Japan, whose treasury bond accounts for 26% of GDP, which is unique in the world. What is the concept of this number? Simply put, Japan needs to spend 2.6 years of its entire national income to repay its government debt. If calculated based on the 2022 fiscal revenue of the Japanese government, even if the government does not eat, drink, or spend a penny, it will take 18 years to repay these debts. So are the governments of these countries crazy? Why do they borrow heavily, and what is the logic behind it? Will the United States default? Why do economists have different opinions? The more the government borrows, the better. How much is more?

Firstly, every government in a country has a need to make money and spend money. Over the past thirty years, 95% of the US government's revenue comes from taxation, while expenditures include public utilities, defense, military, and infrastructure, with most of the time spending exceeding income. This has led to a sustained fiscal deficit, and the government needs to fill this funding gap by issuing treasury bonds. Take a look at the financial situation of China, Japan, the UK, and the eurozone, all of which have been in deficit. Looking at this financial data alone, if it is an individual, it may be considered a loser. But for countries, the situation is different.

The US government has experienced multiple controversies over the debt ceiling, mainly to control government spending from being excessive. In fact, this ceiling is symbolic, and Congress raises it annually, on average once a year. Once the debt reaches the limit, Congress will urgently vote, giving both parties an opportunity to argue. Currently, the Democratic Party is in power, but the majority of the House of Representatives is Republican, so the two parties need to negotiate fiscal spending. The fiscal mechanism in the United States is a bit complex, often involving large-scale government stimulus to the economy, but at other times it is not talked about. Although the setting of the debt ceiling may seem reasonable, in fact, it has been raised 42 times since 1981, on average once a year. The US government has also predicted that a debt default that lasts for several weeks will lead to a 45% drop in the US stock market, with over 8 million people unemployed and serious consequences. So the debt ceiling mainly provides an opportunity for bipartisan debate.

Except for the United States, few countries adopt this debt ceiling mechanism. Except for the United States and Denmark, almost no country has restricted the issuance of its own Treasury bond due to the debt ceiling. Over the past fifty years, global government debt has been continuously increasing. So why do they borrow so much? What are their thoughts? Does this make them unhappy?

Firstly, we need to understand the different logic between government borrowing and our borrowing. The government borrows money to stimulate the economy, especially in times of economic recession, where the government needs to borrow money to increase overall social demand and help the economy overcome difficulties. This is an important theory in modern economics, where governments need to borrow heavily and spend money to stimulate the economy during economic crises or recessions. That's why whenever a crisis comes, the government starts spending money to stimulate the economy, such as during the 2008 subprime mortgage crisis, the 2020 pandemic, and the 1998 financial crisis in Japan. However, an increase in debt does not necessarily directly lead to economic growth, as Japan has been borrowing continuously for the past three decades, but GDP growth has been relatively slow.

Recently, a new economic theory has emerged called the Modern Monetary Theory (MMT), which believes that the government should boldly borrow money because the government's credit is essentially money. As long as there is no inflation, the government should continue to borrow and spend money, which is most beneficial for the economy. Although this theory has not yet been widely accepted by mainstream economics, it has received much attention in recent years.

However, the government cannot borrow money without restrictions, as it needs to consider inflation and market reactions. The government has a special ability to print money. Although the government cannot print money directly, it can indirectly increase the money supply through the central bank's purchase of Treasury bonds, which is called quantitative easing. This means that the government can actually avoid the risk of debt default by printing money, which is why the external debt problem has become more complex. The government can respond to crises by printing money, while other countries need to solve problems by borrowing.

Treasury bonds are different from personal debt for the government. The government has greater flexibility to borrow and spend money. The issue of external debt is relatively more complex, and external investment may amplify economic fluctuations, while the government can avoid the risk of debt default by printing money. Therefore, the United States does have unique characteristics in this regard, as it does not need to consider domestic and foreign debt issues. At the same time, the interest rate is also a key factor affecting government debt. The price of a Treasury bond determines the risk-free interest rate, which affects the entire financial market. So, the logic and limitations of government borrowing are not just about money and debt ceilings, but rather more complex economic mechanisms.

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.