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Can a Government Make Its Debt Disappear?
Jean-Luc Mélenchon during a 2013 conference "The European Crisis and Political Alternatives" in Quito, Ecuador. Image CC BY-SA 2.0 via Cancillería del Ecuador
Jean-Luc Mélenchon during a 2013 conference "The European Crisis and Political Alternatives" in Quito, Ecuador. Image CC BY-SA 2.0 via Cancillería del Ecuador
Imagine you owed $400,000 on your mortgage.
Then your rich uncle died and, in his will, left you a bank. A little while later, you learn that your new bank has $72,000 of your mortgage debt on its balance sheet.
Since you own the bank, and you owe the money to yourself, the obvious solution be to just tear up that part of the mortgage. Right?
That’s pretty much the shape of the strangest current debate in European economics.
Jean-Luc Mélenchon, a leading candidate in France’s 2027 presidential election, has proposed canceling the roughly 18% of French government debt held through the European Central Bank (ECB). His argument, essentially, is that France owes this money to an institution it partly owns.
Why should we keep paying ourselves?
I understand the appeal.
France has too much debt, weak economic growth and a government struggling to control its deficits. Reuters reported this week that French government debt has reached about 117% of GDP.
If you could make nearly one-fifth of that debt burden disappear with a simple accounting entry, why wouldn’t you?
Because one rule applies to government debt just as surely as it applies to your mortgage:
The debt can disappear from one side of the ledger. But the cost doesn’t.
France’s tempting idea: Erase the IOU
Let’s be precise about what exactly Mélenchon is proposing.
He is not saying France should simply stop paying all its creditors. (Private creditors and investors would not be affected.)
Instead, he wants European governments to negotiate a cancellation of government debt held by the ECB.
That distinction is important!
It also explains why the idea sounds almost reasonable.
When a government owes money to its own central bank, isn’t the nation basically in debt to itself?
Joachim Nagel, president of Germany’s Bundesbank and a member of the European Central Bank’s governing council, says no.
Nagel told France’s Le Monde that euro-area central banks are not allowed to cancel national government debt. Doing so, he argued, would amount to monetary financing of government spending – prohibited by European treaties. (Here's the original, in French, if you want to dig a little deeper.)
Let me pause for a moment and explain that point. “Monetary financing of government spending” means letting the central bank – in this case, the ECB – print money to buy French national debt. And then just tear up the IOU. Normally, a central bank loan works like any other loan – when the Fed buys U.S. federal debt, for example, the Fed collects interest payments and then the principal when the debt is paid off.
What’s the problem with that? Well, Nagel warned it could open a “Pandora’s box” that threatens price stability.
I think Pandora’s box is the right metaphor.
Once governments discover central-bank-held debt can simply be erased, an obvious question follows: Why stop at 18%?
If a central bank can print any amount of currency, why do governments need creditors at all? The central bank can just print as much currency as the nation needs to pay the bills that day.
Do you see where this is headed? With no constraint on spending, it’s all too easy to keep printing currency. Which does not, in fact, create more purchasing power – rather, it simply reduces the purchasing power of all other currency in circulation.
That’s not to say such a proposal automatically produces hyperinflation. Even Nagel doesn’t go that far.
But the incentive problem is real.
There is no way to make trillions in debt vanish without consequences. There are only different ways of deciding who pays the price…
There are no painless solutions to too much debt
Governments with overwhelming debt have a fairly short menu of choices.
They can raise taxes.
Cut spending.
Grow the economy faster than the debt.
Formally default or restructure what they owe.
Or they can reduce the real value of that debt over time.
Now, that last option deserves more attention – because it’s both the most subtle and most common form of debt management.
If a government promises to repay you $100,000 and does so, technically it kept its promise. But if the purchasing power of that $100,000 has fallen substantially by the time you get repaid, the government’s inflation-adjusted debt burden has shrunk.
You received every dollar you were promised.
You simply received less value.
Economists have a name for this process: Financial repression.
The sneakiest way governments shrink their debt burdens
Financial repression sounds dramatic – like some kind of mental disorder that requires regular medication and a lot of therapy.
In fact, it’s all but invisible.
Financial repression means keeping government borrowing costs below inflation. Often this requires regulations or central-bank policies that require financial institutions to own government debt. Sometimes citizens, too.
So long as the government pays less on its debt than the rate of inflation, the real value of the debt shrinks. For a heavily indebted government, that can be extremely useful.
For a saver, though, it’s absolutely punishing.
Financial repression isn’t some obscure theoretical possibility.
An IMF working paper published in July studied 17 advanced economies going back to 1920. The researchers found that financial repression peaked after World War II. Then declined as financial systems were liberalized. And then began increasing again after the Global Financial Crisis.
Here’s their conclusion: The same conditions historically associated with elevated financial repression are present today. They believe deliberate financial repression will increase in the years ahead.
Now, an important qualification: That’s not an official IMF forecast.
Still, the historical record it documents is remarkable.
Earlier IMF research found that across advanced economies from 1945 through 1980, real interest rates were negative about half the time. The resulting reduction in government interest costs amounted to roughly 1% to 5% of GDP annually in the countries studied.
Think about what that means.
Governments don’t have to announce:
“We refuse to repay what we owe.”
They can repay. Inflation does debt reduction for them.
But somebody always pays
This is the part of the debt debate I think gets lost.
We tend to discuss national debt as though it were a number floating somewhere above Washington or Paris, disconnected from ordinary life.
It isn’t.
When governments raise taxes to address debt, households pay.
When governments cut spending, families feel it.
And when inflation helps reduce the real value of government debt? Savers pay in lost purchasing power.
That last method is politically attractive precisely because the bill is so difficult to see. You don’t get an invoice marked FINANCIAL REPRESSION.
You simply notice groceries cost more. Insurance costs more. Home repairs cost more. Retirement looks more expensive than it did five years ago – and it’s not really clear why this is happening.
Your bank statement may even show a larger balance than before! Yet somehow that balance buys less.
That is what makes inflation such an effective way to spread the cost of government debt across an entire population.
America has the same math problem
France’s situation is unusually fragile right now, but I think this is more than another European political squabble.
Our national debt recently passed $40 trillion. Annual interest costs have climbed well over $1 trillion.
The U.S. has enormous advantages France does not, including the dollar’s central role in the global financial system. That gives Washington more room to maneuver.
But it doesn’t change the math. Last week, the Treasury Department auctioned off $797 billion dollars in debt (that’s to finance new spending and to refinance old debts).
The already huge numbers are growing faster and faster…
Now, I don’t know how the federal government will ultimately deal with its debt burden. Nobody does.
Maybe stronger economic growth will do more of the work than pessimists expect? Maybe elected officials will eventually accept painful tax and spending decisions? Maybe inflation will remain low enough that financial repression never becomes a major part of the solution?
But history tells us it belongs on the list of possibilities.
And if you are planning for retirement, you don’t get to wait 20 years to discover which path Washington chose.
Central banks are concerned – and they’re doing something
Interestingly, the institutions responsible for managing national reserves are already placing greater emphasis on an asset that does not depend on another government’s promise to pay: Physical gold.
A World Gold Council survey reported by Reuters in June found that a record 45% of central-bank reserve managers expected to increase their gold holdings during the next 12 months.
Among the leading reasons they gave were gold’s performance during crises, its ability to retain value over the long term and its diversification benefits.
I don’t want to overstate what this means. Central banks are not buying gold because they all expect governments to inflate away their debts.
Nor does physical gold offer financial certainty – its price rises and falls, all the time, every day.
The lesson is simpler: Gold has no issuer. Physical gold is not somebody else’s debt. It doesn’t require a government, corporation or central bank to keep a promise to give it value.
That makes physical gold fundamentally different from the debt-based obligations at the center of today’s debate.
France is asking whether some of those obligations can simply be erased. The IMF is reminding us that governments have historically used inflation and financial repression to manage large debt burdens.
And central banks themselves continue to add physical gold to their reserves.
For ordinary savers, I think that is worth contemplating.
You cannot control how Washington ultimately deals with $40 trillion in national debt. You cannot control future inflation, interest rates or monetary policy.
But you can control whether all your savings depend on the same system.
Diversifying a portion of your savings with physical precious metals is one way to shelter against monetary uncertainty – not because gold guarantees a particular outcome, but because it gives you ownership of something tangible that isn’t another institution’s promise to pay. Learn more about the benefits of physical precious metals ownership here.
Sometimes the best response to a problem nobody knows how to solve is simply making sure you don’t have all your money riding on one solution. Diversification is tough for some people, because it requires humility. The humility to accept that we don’t know what the future holds. That can be scary, and it can be intimidating – but I believe those honest feelings are better than false confidence.
If you agree, I encourage you to learn more about diversifying your savings with physical gold. Request your copy of the free Gold Information Kit to start your due diligence.
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About Peter Reagan
Peter Reagan has covered precious metals and the economy for Birch Gold Group for over 15 years. His articles have been featured in several leading publications, including Newsmax and Zerohedge. At Birch Gold Group, Peter leverages his deep market insights to help educate website visitors and customers on why they should consider diversifying their savings into gold and other precious metals, and how that process works. Due to this commitment to education, his content has become a trusted source of information throughout the industry.
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