In Montesquieu’s The Spirit of Laws, published in 1748, one reads that: “Some have imagined that it was for the advantage of the state to be indebted to itself: they thought that multiplied riches by increasing the circulation” (Montesquieu, 183). The reasoning behind this statement had to do with the exclusive use of gold and silver for money. By issuing government bonds that households and businesses were willing to hold instead of hoarding gold and silver, more gold and silver became available to circulate as a medium of exchange. Alexander Hamilton, first secretary of treasury of the United States, also saw advantages in a public debt. He argued that interest-bearing government bonds gave businesses a place to earn interest on capital when it was not in use.
Most national governments of highly industrialized economies have public debt. The degree of indebtedness can be a matter of concern. The main consideration in debt, private or public, is the amount of income available to repay it. Doubling one’s debt while doubling one’s income, does not raise the debt burden or the chance of default. Economists use the ratio of public debt to gross domestic product (GDP) to measure the
degree of indebtedness of a particular government. As long as GDP grows faster than public debt, the ability of a government to pay off its debt is always improving. Below is a list of countries with public debts measured as a percent of GDP.
Public debts often soar significantly during wars. Following the Napoleonic wars, Great Britain’s public debt as a percent of GDP stood close to a dizzy 300 percent. It steadily fell, dropping
below the 50 percent range by the eve of World War I (Miles and Scott, 606). By the end of World War II, the United Kingdom’s debt had climbed to a lofty level of 250 percent of GDP. The United States finished World War II with a public debt above 100 percent of GDP (Miles and Scott, 266). Inflation helps countries reduce the burden of public debts. In the post–World War II years, inflation helped reduce the public debt
burdens of the United Kingdom and the United States. The stress of wartime finance, coupled with war reparations sent post–World War I Germany into a frenzy of runaway inflation.
It is true that a government should never face default if its debt is denominated in its own currency. It can always print up the currency to redeem a debt, but the outcome is likely to be inflation and economic chaos. Governments usually turn to hyperinflation to get out from under a debt only if creditors have lost confidence in the government and are withholding credit. All the U.S. government debt is denominated in U.S. dollars. Governments in developing countries often contract debt denominated in the currency of a foreign government. These governments can face default if they run short of foreign currency reserves.
In the United States, the public debt as a percent of GDP steadily fell from the end of World War II until around 1980 (Miles and Scott, 266). It reached a trough roughly at 25 percent of GDP. In the 1980s, the U.S. public debt as a percent of GDP turned upwards with larger budget deficits, reaching a level of 70
percent of GDP in 1996 (OECD, 2008). The public debt as a percent of GDP steadily fell from 1997 until 2001, and then began climbing. In 2008, the OECD Economic Outlook was expecting the U.S. public debt as a percent of GDP to reach 80 percent in 2010.
The public debt equals the accumulation of past budget deficits. The budget deficit is the annual shortfall in government revenue relative to government spending. A public debt indicates that over a span of years the annual budget deficits outweigh annual budget surpluses. Even if a public debt remains within a moderate range, observers and critics claim that the annual budget deficits have harmful effects. Firstly, these deficits subtract from the amount of credit available to finance house purchases and business capital expansion.
Secondly, they elevate interest rates, and create a class of financial assets that pay good interest rates at low risk. Foreign investors in the pursuit of these government bonds bid up the value of the domestic currency in foreign exchange markets. A strongly valued currency in foreign exchange markets makes imports less costly to domestic consumers and home exports more costly to foreign consumers. Critics charge that imports
swell while exports shrink, and that the result is fewer domestic jobs.
Miles, David, and Andrew Scott. 2002.
Macroeconomics: Understanding the Wealth of Nations.