Is Government Debt a Problem?
In Theory, No; in Practice, Yes

A detailed report by the IMF cautions that government debt around the world is not being reduced enough, or is even on the rise. Read about when debt can put governments into a difficult position, and what the current situation means for investors.

The International Monetary Fund (IMF) and the Congressional Budget Office (CBO), which reports to US Congress, have recently issued clear warnings about global debt growth over the past ten years.

Both reports concede that, in theory, government debt is no problem in a country's own currency. However, the situation is different in practice. After all, in theory, a government could always print enough money to cover debt in its domestic currency. Monetizing debt in this manner could be an ultima ratio if interest rates spiral out of control, or political leaders are no longer willing to pay this debt. Neither situation is likely at present.

Countries with a relatively high national debt, such as the US, can hit a downward spiral after a certain point.

Burkhard Varnholt, CIO Credit Suisse (Switzerland) Ltd.

The full report of the IMF cautions that government debt around the globe is not being reduced enough, and is even on the rise in the US and China –even though the current economic boom would be favorable to reducing debt.

How Debt Becomes a Problem for a Country

Keynes discussed the options and limits of debt and fiscal policy. Depending on the circumstances, debt-financed fiscal policy can absolutely enable sustainable development, but it can also do the opposite. It all depends on the right balance.

China has relatively low debt, and can provide growth momentum by making long-term investments in the environment, education, and mobility, for instance. Countries with relatively high debt, such as Japan, the US, and Italy, can cross a threshold into a downward spiral of debit interest, deficits, and forced austerity, which can put a stop to even important long-term investments. If this threshold is reached, then debt becomes a problem. However, countries that strike this balance will be among the silent victors, and Switzerland is certainly in this group.

Swiss Government Debt: All Systems Go?

However, the IMF does make the key distinction that alongside explicit government debt, there are implicit liabilities for pensions and healthcare. These are unclear in many government budgets at present, but are essential in order to assess a country's debt situation fairly. Below is an overview of selected countries:


Actual government debt, including implicit liabilities

Debt ratio (debt-to-GDP ratio)
Source: International Monetary Fund

There is one unpleasant detail: Swiss government debt in particular rises when taking implicit liabilities into account. Explicit government debt accounts for just 43% of GDP in Switzerland. However, additional government liabilities for pensions and healthcare increase this by another 122%.

What Does This Mean for Investors?

  1. Servicing the debt could result in conflicts of interest, not so much in the next two to three years but in the next ten to 20. In recent years, interest rate decreases outpaced debt increases. The result, as mentioned above, was that debt service in many places is lower than rising debt levels might suggest.
  2. It is unlikely that developed economies would pay off debt through inflation. They have too much to lose for that. On the contrary, it is more likely that long-term interest rate pressure will remain, perhaps in the style of Japan. More fiscal repression, such as increasing taxes, more redistribution, and more withholdings seems the more likely outlook for the medium term.
  3. A diversified portfolio, generally with a high equity ratio, could be a useful tool if financial repression seems likely.