First world problems

Setting Trump and tariffs aside for a moment… We’re facing a new year, but some familiar concerns. We hear that big economies can’t grow any more; and that government debt must spiral higher.

Not necessarily. Since Russia’s invasion of Ukraine in February 2022, the US economy has grown by an annualised 2.6%, and China’s by 4.9% – faster than usual for the US, slower than usual for China, but respectable rates by any standards.

For sure, Europe has lagged badly, as we were reminded last week – the eurozone’s annualised rate over the same period was just 1.1% (with Germany shrinking, at -0.1%), the UK’s 0.6%, and Switzerland’s 1.1%. But overall, there is still big-economy growth out there.

Corroboration seems to come from low unemployment rates (intriguingly, even in Europe).

In the bellwether US economy, growth is being led by consumers, and is delivering higher tax receipts. But it has owed something to government spending too. Generally, budget deficits may indeed get bigger before they get smaller, as we have noted; debt ratios are rising; and bond yields have normalised.

This does not however mean that debt spirals are imminent, and that 'bond vigilantes' need be on the prowl again (at least, not on this account – inflation risk and monetary policy may yet get them going).

Deficits (and, after the pandemic, debt ratios) have been bigger in the past, and there is little visible link between them and the level of bond yields. There are few signs of a bond-buyers’ strike: no big government has yet found itself unable to borrow at or close to prevailing yields. Indeed, some government bonds – notably, US Treasuries – remain in global demand as safe haven assets.

Behaviourally, bond yields are driven more by the economy than by government deficits and debt (as the pandemic made very clear). Purchases of bonds – more recently, sales – by central banks do blur the picture, but only a little. And current yields in turn take some time to shape government spending: even at today’s deficits, new borrowing is small relative to outstanding debt, and average maturities for the big economies range from six years in Germany and the US, to fifteen in the UK.

Meanwhile, despite obvious current pressures on government budgets (EU defence spending, for example), on a long-term view, policies can change. Debt burdens can remain manageable.

In the US, the DOGE may disappoint, and federal debt ceilings and shutdowns still loom large in the US market narrative, but Trump’s dislike of government spending seems genuine. And while taxes will fall in 2025/6, if/when America decides to raise them again, it could add five percentage points of GDP to tax revenues and still be a low-tax (and small government) economy.

For the EU, September’s candid Draghi Report is another indication that the days of counter-productive employment protection and disincentives may be numbered.

For the UK, the new government is boosting spending more than taxes, but not outlandishly, and it is also asking some difficult questions (for a Labour administration) about health and welfare spending.

As we see things, then, talk of no growth and a government debt 'death spiral' (Ray Dalio’s recent description of the UK’s alleged predicament) remains overblown. It is a distraction, perhaps, from issues which better deserve our collective attention – such as whether any extra growth is best fostered by trying to boost demand, or supply; and how a still-prosperous first world is going to compensate its poorer neighbours for the looming energy transition.

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