Spiralling national debts may well result in many years of high inflation

It is widely known that many leading Western nations are becoming caught up in a debt spiral, which is now the most serious since the aftermath of World War Two. In descending order, the worst affected of prominent countries in terms of high debt to GPD (2024 figures) include Japan 237%, Greece 154%, Italy 135%, USA 124%, France 113%, Canada 111%, UK 94%, and Australia (currently well down the list at) 44%.

Australia had started with very low national debt but is rapidly catching up, with big deficits now predicted as far as the forward estimates can see. Australia's gross debt is on track to crack the $1 trillion mark in a matter of weeks according to the Treasury. This is despite taxes and royalties from mining (especially iron-ore) booming, and rising personal income taxation.

Worse still, our national debt is being used to fund a big rise in social spending, instead of economic investment, that could have enhanced future incomes and our ability to repay. Also, a lot of supposed economic investments (e.g. Snowy 2, Inland rail, Suburban Rail Loop, most "renewable" projects) are also uneconomic and won't contribute to Australia's ability to repay.

High debts and continuing deficits have been explained away by arguments such as "debt does not matter" and that governments can rack up as much national debt as they like (without ever worrying about paying it off) because "we owe it to ourselves".

All this is simply misleading.

In terms of national debt, borrowers and lenders are different types of entities, and growing debts create big imbalances within and between economies. They also place a rising interest burden on national budgets. High debt countries and provinces also eventually risk a loss of confidence in their governments as debtors. This can eventually put entire financial systems at risk.

The Northern Territory and Victoria are both rapidly losing fiscal credibility and may well require support from the Commonwealth.

The NT's net debt (much of it built up by the outgoing Labor government) is approaching $14 billion, the highest per capita in Australia. It leaves the NT with by far the highest net debt per capita in the nation, coming in at almost $48,000 per person for 2025-26. This is equivalent to a net debt to revenue ratio of 121 per cent. Despite plans to achieve an operational surplus, infrastructure spending is projected to cause the Territory's net debt to continue rising. Interest paid on NT debt is expected to reach $911 million annually by 2029.

Victoria's state debts are also amongst the worst of provincial governments in the world, with much of the problem due to irresponsible government spending on infrastructure projects. The state's total government sector net debt was almost $151 billion last financial year, with the amount Victorians paid in interest amounting to more than $6.7 billion. Victoria now has the highest taxes, highest net debt, and least competitive business and investment conditions of any state in the nation.

When governments squander money, this seriously impacts investment and future productivity. In the end, rising taxes or other measures to control debt become inevitable. Governments still wanting to spend more, have been known to activate the printing press (i.e. inflate the money supply) if central bankers won't or can't prevent them.

Historically two contrasting approaches have been used to reduce national debts. Governments can either repay debt or inflate it away.

In Australia we have the precedent of the Howard government, which paid off $96 billion of debt inherited from earlier eras. The Howard government achieved this through running a series of Budget surpluses, helped by a substantial contribution from the sale/privatisation of public assets and by a strong economy.

This solution to debt seems unlikely to be repeated. Firstly, having sold off assets like Telstra, the Commonwealth Bank, and much of the electricity industry, there are few obvious candidates remaining for potential sale. Secondly, given politicians' appetite for spending and for staying in power, the will for further increases in taxes or major cuts to spending does not seem to be there. Cost-cutting budgets would also leave little room for conservative governments in Australia to push pet causes like defence spending or assistance to private schools, should they get elected.

The other avenue to reducing national debts is to use the same methods that were used in the post-war period to dramatically reduce debt. Britain's post-war experience (partly copied by other countries) is a classic case in point.

During the 1930s Britain's debts were already high, reflecting residual debt from the First World War and costs associated with the Great Depression. The cost of WW2, however, meant that by 1946 Britain's public debt had reached 2.3 times income.

Wartime controls ensured that the yield on government bonds was kept low. For public debt to remain manageable interest rates needed to be kept down for a prolonged period. This was done by continuing controls on capital issues, credit and foreign exchange through the 1950s. Full liberalisation of the capital account of the balance of payments did not occur in the UK until as late as 1979.

The most important factor in the shrinking burden of the debt was 7 per cent annual inflation, which eroded debt in real terms. Negative real rates of interest effectively ensured that bondholders bore the brunt of debt reduction. Interest transfers from taxpayers to bondholders in the post-war period ended up being limited to no more than 6 per cent of national income. Bondholders, who originally paid for the second world war and expected their money back afterwards, ended up with an unexpectedly large share of the final bill.

Britain's public debt had the side effect of depressing economic growth, which in the 1950s and 1960s was disappointing compared with its European neighbours. At the same time, Britains ratio of public debt to GDP fell from 2.3 times national income in 1946 to just 34 per cent in 1991.

Of the vast debts Britain had accumulated during the Second World War, one-third of the total £3.5 billion was owed to British India. During the War, India acted as a supply base, resulting in a large trade surplus with Britain, which was credited to India in sterling loans. The requisitioning of Indian resources (especially food) for the war effort was extensive and, despite warning it could result in famine, the British opted to continue exporting rice from India to meet military and other needs. A result was that a major famine resulted, especially in Bengal, around 1943.

By December 1945, these balances peaked around £1.3 billion. A resolution to the outstanding 'sterling balances' was a priority for both leading Indian anti-colonial political parties, and for the U.S. Treasury (another major creditor). The 1947 Financial Agreement recognised a debt to India of about £1.16 billion. Following the partition of India, a portion was transferred to Pakistan.

The British Government would only agree to the slow release of these funds in order to manage Britain's balance of payments. The 30 per cent devaluation of the pound in 1949 significantly reduced the purchasing power of the remaining balances, causing economic difficulties for India. The decline in the value of sterling and high rates of inflation allowed Britain to reduce its debt burden over time at the expense of its creditors.

In today's capital markets, it is a lot more difficult for governments to control yields or monopolise the world's savings, though it may be expedient to move to an era of more controls. In the case of the US, whose dollar has been used as a reserve currency, this role would be threatened by an era of high domestic inflation.

Experience indicates that it is hard to reduce debt in times of deflation and depression. If debt is not cancelled, it must be either repaid or inflated away. There will be a strong temptation for some countries to adopt the latter option.