Debt is an evergreen topic in financial writing, whether it involves the perks and perils of individual consumer debt, corporate debt or national debt. While the national debt of the United States has never really ever slipped out of the national dialogue, events over the past decade have intensified the discussion.
Tax cuts, spending on multiple wars and a major recession induced by the collapse of the housing market have combined to spike the U.S. debt burden, while sovereign debt issues have all but blown up the economies of Southern Europe (not to mention the banks, insurance companies and other investors who bought that debt). What's more, debt has started to increasingly factor into bilateral and multilateral political squabbles. While debt is fundamentally necessary to the operation of a national government, it is increasingly clear that debt can be limiting and dangerous.
Loss of Discretion
There may be nothing more central to a country's independence than the freedom to allocate its resources more or less however the populace wishes. High levels of debt directly threaten the ability of a government to control its own budget priorities.
Debt has to be repaid; while collectors may not show up at a nation's borders, a failure to repay prior debts will typically, at a minimum, result in significantly higher borrowing costs, and the availability of credit may vanish altogether. What this means, then, is that interest payments on debt are basically non-negotiable spending items. The U.S. faces this problem in 2012.
Interest on the national debt is likely to take up more than 6% of the 2013 federal budget. That's a quarter-trillion dollars that could be spent elsewhere or returned to citizens as lower tax rates. What's more, some readers may agree that the actual figure is higher than 6% - Social Security benefit obligations are not debts like T-bills or bonds, but they are balance sheet liabilities and many analysts argue that pension benefits (which are what Social Security benefits basically are), should be included in corporate liquidity analysis.
Going beyond year-to-year budgets, high debt loads also limit a nation's policy options when it comes to stimulating growth or neutralizing economic volatility. Countries like the U.S. and Japan really do not have the debt capacity to launch a second "New Deal" to stimulate employment and/or GDP growth. Likewise, debt-fueled spending risks over-stimulating the economy in the short-term at the cost of future growth, not to mention that it incentivizes the government to keep interest rates low (as high rates worsen the debt burden).
Loss of Sovereignty
Countries that rely on other nations to buy their debt run a risk of becoming beholden to their creditors and having to trade sovereignty for liquidity. Although it probably seems unthinkable today, there was a time when countries would actually go to war and seize territory over debts. The well-known Mexican-American holiday Cinco de Mayo actually doesn't celebrate Mexican independence, but rather a battlefield success over France in an invasion launched by France over suspended interest payments.
Actual military action over debt may no longer be tenable, but that doesn't mean that debt cannot be a tool of political influence and power. In disputes over trade, intellectual property and human rights, China has frequently threatened to reduce or cease purchases of U.S. debt - an act that would very likely drive up rates for the U.S. government. China made a similar threat to Japan over territorial disputes related to the Senkaku/Diaoyu islands in the East China Sea.
Readers also need only look at what has happened to Greece and Spain to see how excessive debt imperils national sovereignty. Due to its inability to pay its debts and a mutual desire to keep Greece in the eurozone, Greece has had to accept various external conditions from the EU regarding its budget and national economic policies in exchange for forbearance and additional capital. Since then, unemployment has soared, civil unrest has grown and Greece is effectively no longer in charge of its own economic future.
When it comes to the issue of debt and sovereignty there is most definitely a distinction between internally and externally owned debt. In 2011, Japan's debt amounts to almost triple its GDP, with more than 90% of it being domestically-owned. So while China's threats are relevant given that it is the largest foreign owner of Japanese debt (about 20%), the absolute amount of influence it can wield is pretty modest. On the other hand, the majority of Greece's national debt was owned by non-Greeks, making the Greek government much more beholden to the goodwill and cooperation of other countries.
This domestic/foreign dichotomy does create a host of problems pertaining to sovereignty. Do German banks and/or government officials now have more say in Greece's economy policies than Greek voters? Likewise, do fears of debt downgrades (or unsustainable borrowing costs) push countries to shape national policies around the decisions of rating agencies? At a minimum, it does lead to questions as to whether a government is prioritizing foreigners (and/or wealthy citizens) over the interests of the average citizen, and it's certainly true that debt repayment strengthens those foreign creditors holding the debt.
Of course, it's not as though questions of sovereignty are new. The entire euro system is an explicit compromise of sovereignty - member governments surrendered monetary policy control in exchange for what they expected to be better overall trade conditions and cheaper access to debt.
Loss of Growth
National debt also needs to be assessed in the context of what it can do to a country's long-term growth capacity. When a government borrows money, it is basically (if not literally) borrowing growth and tax revenue from the future and spending it today. Said differently, national debt robs future generations of growth for the benefit of the current generation.
Historically, when that spending has gone towards projects with long productive lives (like roads, bridges or schools), it has worked out, but when the money is used for transfer payments, unneeded infrastructure (as in the case of Japan), or non-productive activities like war, the outcomes are less positive. Most economists accept that post-World War I austerity probably led to World War II. Nations felt pressure to quickly repay debts accumulated during the war, but higher interest rates led to lower economic output, which in turn led to more protectionism.
There is always a trade-off between taxes, inflation and spending when it comes to debt repayment. That debt has to get repaid eventually, and each choice has consequences. Raising taxes reduces economic growth and tends to encourage corruption and economic inequality. Stoking inflation reduces the present value of money and harms savers. Curtailing government spending reduces growth and can be highly destabilizing to an economy in the short-term.
Debt also imperils growth through the crowding-out effect. Sovereign debt issuance sucks up capital (savings) that corporations or individuals could use for their own purposes. Because the government is always the largest hog at the trough, other capital-seekers have to pay more for capital, and worthwhile value-adding projects may be abandoned or delayed because of the higher cost of capital. Along similar lines, because governments usually get a preferential price for capital and don't operate on a net present value basis (projects are launched more for political or social reasons than economic return), they can effectively push companies and private citizens out of markets.
Relevance to Individuals
While individuals and families cannot run their affairs like governments do (they can't run an indefinite budget deficit, and it's not a good idea to declare war on a neighbor), there are nevertheless lessons here for individuals.
Countries don't have to worry about having national assets repossessed, but people do. Individual debt can create problems that spiral out of control and destroy a person's ability to build assets or savings, leaving that person in a situation where he or she is forever working for the bank or other creditors and not for themselves.
Most importantly, individual debt limits options and flexibility. Many people have been unable to seek better jobs outside their communities because an underwater mortgage prevents them from moving. Likewise, many people cannot leave unsatisfying jobs because they are dependent on that weekly or monthly paycheck. While people free of debt can live their lives with a great deal of freedom, individuals buried under debt will find their options perpetually limited by what their budget, creditors and credit rating allow them to do.
The Bottom Line
Debt is neither good nor bad in and of itself. Just as a life-saving drug can be fatal at excessively high doses, so too can debt cause great harm when taken to excess. When it comes to national governments, debt is alluring, addictive and dangerous. Debt allows politicians and citizens to live beyond their means; pushing hard decisions down the road and allowing the government to buy goodwill through largesse. At the same time, however, it is almost impossible to contemplate large projects without debt, nor to smooth over the minor ups and downs of the economic cycle and the timing differences between tax receipts and spending demands.
As a result, governments have no choice but to learn to live with debt and use it responsibly. Living with debt carries responsibilities, however, and national governments would do well to realize that going too far down the road of debt-fueled spending risks their own freedom of choice, sovereignty and long-term growth potential.
More From Investopedia