HomeDebt and What to Do With It?

Debt and What to Do With It?

27 October 2020 By Mircea Vasiu

One of the biggest unanswered questions in the current economic crisis is what to do with the debt that piles up? As a response to the coronavirus crisis, nations around the world have borrowed enormous amounts of money to tackle high unemployment and business closure. 

The good news is that central banks made it easy for states to borrow. By lowering the interest rates and actively doing quantitative easing, the central banks effectively contributed to lowering the yields, so the cost of borrowing did come down significantly.

However, the debt to GDP ratio increased. It reached higher/unsustainable levels even before the economic crisis in many of the developed economies. Nowadays, with the GDP affected by the recession and the debt on the rise, the ratio grows even faster.

How to Deal with the High Levels of Debt

Debt is a key concept in economics. The principles for a country are similar to those for a family. For example, if a family’s monthly income is X, but the family spends Y, and Y>X, it must borrow at the end of the month the difference Y-X. For this difference, it must pay an interest to the creditor entity – typically a local, commercial bank.

Depending on the entity that lends the money and the contract signed, the interest varies from only a few percentages to a couple of tens of percentages or more (e.g., credit cards). When debt becomes unsustainable (i.e., interest and principle impossible to pay), the family goes into trouble. It will look to refinance the debt, etc.

The same is valid for a country, with some notable exceptions. One of them, and perhaps the most important one, is that some countries (not all), can “print” their way out of a debt trap.

More precisely, when the country is borrowing in its own currency, it will have an easier time to pay back its debt. How come? The explanation comes from the fact that the central banks own the monopoly over the currency. Put is simply – it could print as much money as it wants to pay its debt, even at the cost of devaluing or debasing the currency. However, if other nations (countries that lent money to it) perceive that you do it intentionally, they will stop lending and the country gets in the same place where the family in the earlier example did.

The moral of this story is that debt is the last thing everyone should worry about at this point in the crisis. As long as countries can create money and interest rates are so low – debt is not an issue.