New data analysis reveals how private sector debt is increasingly vital to an understanding of the global economy, yet it is often overlooked by economic analysis as that is normally focused on government debt, even though private sector debt is much bigger. Richard Vague elaborates
It’s fair to say that elected officials, policy makers and business executives alike would benefit from a deeper understanding of debt in the British economy. What is widely misunderstood is that increased government debt increases household wealth. Government money does not disappear when it is spent. Instead, it largely goes into the accounts of households, directly through salaries and other payments, and indirectly through the salaries of those who work for vendors of the government.
In fact, during the three years of the pandemic, ie 2020-22, UK government debt increased by £602 billion, but household wealth increased by a much greater amount, an estimated £1.7 trillion. That increase came from government spending and payments to households, plus the increase in the value of stocks and real estate that came from the flood of increased pandemic-era government debt and spending.
In total, household wealth in the UK, at £12.6 trillion, towers over the £2.5 trillion in government debt and households own much of that UK government debt as an asset.
But doesn’t excessive government debt cause inflation? No, for developed economies, there is no compelling evidence that it does. There was no inflation in major Western economies after the massive government debt growth that followed the global financial meltdown, nor in Japan after the massive government debt growth that followed its 1998 crisis.
Analysing inflation & interest
There is also a similar lack of evidence that high money supply growth brings inflation. The notorious 1970s bout of inflation was largely a function of the ten-fold increase in the price of oil to $39 a barrel, which came about with the 1973 Yom Kippur War and the Iranian Revolution in 1979.
This inflation was vanquished not by high interest rates, as many believe, but by US domestic oil price deregulation, which drove North American oil production. This grew from 12.2 million barrels a day in the late 1970s to 15.3 million barrels by 1984 and thus brought the price of oil to $12 per barrel by 1986 – sending inflation tumbling to two per cent.
But isn’t the Liz Truss tax cut debacle proof of the dangers of high government debt? I’d say rather that it had more to do with the weak pound and gnawing trade deficit than the size of the government’s debt. Liz Truss was attempting to emulate her icon Margaret Thatcher in cutting taxes to stimulate a rebound, but the economic circumstances surrounding the Truss cut were vastly different than those in the Thatcher era.
Thatcher had a two per cent trade surplus that contrasted markedly with Truss’s problematic 3.5 per cent trade deficit, a deficit exacerbated by Brexit and the Ukraine war. That puts downward pressure on the currency, bringing higher import expenses, as well as inflation and upward pressure on interest rates. The UK’s unfavourable position here could mean years of higher prices for consumers.
Thatcher had other key advantages as well, most notably low levels of private debt which meant that the private sector had ample room to grow through increased spending on investment. For Thatcher, the ratio of private debt to GDP was a very low 56 per cent, while for Truss it was almost triple that level at 150 per cent.
Surge in private debt lending
Truss, along with many economists, wrongly believed it was Thatcher’s tax cuts that brought the economic growth of the 1980s. Instead, it was a £31 a year surge in private debt lending that resulted in £33 billion a year in nominal GDP growth during the first half of the 1980s. Thatcher actually cut spending and increased taxes during the first part her tenure, though she did cut the top rate of the income tax.
That lending boom brought euphoria in its initial years, taking the ratio of private sector debt to GDP from an ultra-low 58 per cent in 1980, shortly after Thatcher’s ascension to prime minister, to 115 per cent by 1990. This made it one of the most rapid escalations of private sector debt in Western economic history.
But over-lending usually brings an economic hangover – and it was the case here too. Too many buildings had been built and business had overexpanded beyond the level justified by demand. John Major inherited the brunt of this, with a recession in 1990-91and unemployment rising from 6.8 per cent in 1990 to 10.4 per cent in 1993.
Policymakers and business leaders should examine the misconceptions surrounding government debt and recognise that its growth can bring household wealth and does not lead to inflation. There is room for a strategic increase in key areas of the British government’s budget and there are any number of areas that are ripe with opportunity and could readily boost the UK’s growth and the business environment – from worker training and green energy to infrastructure spending and much more. Britain should look to take advantage of that opportunity.
Richard Vague is an investor and entrepreneur and author of the new book, The Paradox of Debt – A New Path to Prosperity Without Crisis. He has served as the Secretary of Banking and Securities for the Commonwealth of Pennsylvania and co-founded two US banks: First USA, which was sold to Bank One, and Juniper, which was sold to Barclays