When it comes to age, 70 is supposed to be the new 50. A similar rethink is on the cards for public debt. Governments are spending freely to combat the economic havoc wrought by the coronavirus. While borrowing will inevitably jump relative to economic output, investors will have higher tolerance thresholds.
The U.S. Senate on Wednesday backed a $2 trillion bill to help the American economy. Germany has announced spending and tax plans worth 4.5% of gross domestic product, France’s package is worth about 2% of GDP, and Italy has already adopted emergency measures worth 1.4% of GDP, according to the International Monetary Fund. As it’s unclear how long the lockdowns will last, analysts are struggling to forecast either debt or GDP. Still, Goldman Sachs on March 24 predicted Italy’s debt-to-GDP ratio, which was 137% in the third quarter of 2019, would rise to 161% this year. The investment bank expects the comparable metric for France and Spain to surpass 100% by some margin.
Bond investors would normally look askance at government debt exceeding the value of a country’s yearly output. Not in a post-virus world. First, GDP would plummet further and longer without emergency spending, so the debt burden is set to rise anyway. Second, since public debt is rising relative to GDP everywhere, the level at which bond investors get worried will change. As former European Central Bank chief Mario Draghi wrote in the Financial Times on Wednesday, much higher debt levels will become a permanent feature.
A third reason why public debt of around 150% of GDP might become the new 100% is that Draghi’s old employer and other central banks are buying ever larger amounts of it. Federal Reserve Chairman Jay Powell has committed to buying as much as is needed and expanded the range of assets that can be acquired. Meanwhile, the ECB has dropped self-imposed limits that applied to a previous asset-buying scheme from its new 750 billion euro Pandemic Emergency Purchase Programme. That should help keep a lid on bond yields.
Some will worry that such stimulus will lead to higher inflation. But it would be counterproductive to fret about future price increases rather than the immediate threat of deflation and economic depression. Higher debt levels are here to stay.