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A surge in government debt: what’s the big story?

Recent decades have brought a succession of unprecedented global events, leading some to view the world as in a state of ‘permacrisis’. Faced with exogenous shocks to their domestic economies, governments have resorted to increasing their borrowing to fund their way out of crisis after crisis. The IMF (International Monetary Fund) rang alarm bells recently, with its forecast that US government deficits are set to rise especially fast. We take a look at how these debt levels are measured, what efforts have been made to contain them, and their repercussions on financial markets.

The tally of US government debt dwarfs all others, totalling $1.7 trillion as of September 2023. But the US is also the world’s largest economy and can afford to service a higher level of debt. It is for this reason that government debt is generally viewed not as an absolute figure, but as a percentage of a country’s gross domestic product (GDP). The US deficit hit 6.3% GDP in September vs 5.4% a year earlier. The IMF has forecast that combined US deficits could reach 7.4% GDP in 2024.

But it was not always like this. In the years following the Global Financial Crisis (GFC), a number of eurozone economies lurched through successive crises, pushing some to the brink of default. The founding principles of the eurozone included strict limits on government deficits of 3% GDP, which were not to be breached without penalty. Despite a temporary surge in government debt as a result of the Covid-19 pandemic, when these rules were suspended, eurozone member states have made significant efforts to reduce their debt levels. Now the IMF forecasts a total eurozone deficit of 3.6% GDP in 2023, falling to 2.7% in 2024.

On the other side of the Atlantic, however, the huge sums of US borrowing unleashed during the Covid-19 pandemic have not yet been addressed. It has proved difficult to gain consensus on next steps at a bipartisan level, whether for tax rises or spending cuts. The US is not alone in having a rising debt to GDP ratio. China recently raised 1 trillion yuan or $137 billion of sovereign debt, as a disaster relief fund following a spate of natural disasters. This will push China’s deficit to GDP ratio up from 3% to 3.8%.

The impact of increasing levels of government debt can often be detected in the government bond or sovereign debt markets. It’s a simple question of supply and demand. While the US Treasury bond market is immense, the absorption of a wave of new debt has proved challenging throughout the autumn. At a time when global financial market confidence is rattled by uncertainty over the likely path of interest rates, a flood of new issuance from the government has contributed to bond yields surging to levels not seen since the Global Financial Crisis.