This is a detail of “Dividend Day at the Bank of England” by George Elgar Hicks, a painting that can be found at the Bank of England. It should remind us that at the time this post talks about, although it was the central bank of the UK, the Bank of England was privately owned, with shares that paid a dividend. It was only nationalised in 1946, after the 2nd World War.
Often what seems obvious common sense at first sight turns out not to be so simple.
Over the last few years it has become commonplace to accept that pretty much all western countries are radically over-indebted, to the degree that our very futures are at risk… not to mention that of our children and grandchildren. Furthermore, we are told, these levels of debt actually seriously slow down growth: the destructive meme is doing the rounds that debt/GDP in excess of 90% leads to significant slower expansion of the economy. There are all sorts of aspects of this sadly mistaken dogma that are simply wrong, and I will be examining a number of them in future posts over the coming weeks. But one of the problems with this naïve view is that it flies in the face of history.
For example, take a closer look at what happened in one of the countries whose current government is most rabid about reducing debt from “unsustainable” levels. The Victorian era began with the United Kingdom heavily indebted: the Napoleonic wars had cost the country hugely, and by Waterloo in 1815, the debt/GDP of the UK was almost 225%. But it didn’t stop there: for another six years of peacetime the debt/GDP ratio continued to grow, peaking at over 260% in 1821. By today’s standards the country’s debt was positively monstrous: put in context, when the UK’s present government was elected in 2010 with its clarion calls of debt reduction, the debt/GDP stood around 65% of GDP, or almost exactly ¼ of its peak some two-hundred years previously, and WAY below the average over the whole period since 1800 (which is over 110%).
In the one hundred years between Waterloo and the beginning of the next big war in 1914, the UK’s debt/GDP was cut by about 90% from over 260% to less than 30%.
During that time, real GDP growth averaged 2.1%, which was about double the average GDP growth for the previous 100 years. And which is higher than the average real growth rate during the almost 100 years SINCE 1914 of 1.95%.
But given today’s fashionable though totally erroneous views on government debt and growth, the most interesting feature of that period is that for the first 50 years, when the debt/GDP ratio was more than 90%, real GDP growth averaged 2.5%, and at a significantly lower average of 2% for the next 50 years, when the ratio was below 90%! Furthermore the Victorian era is generally considered to be the height of the British Empire and of Britain’s influence and power across the globe. Halcyon days indeed; and not blighted by misguided ideological views about debt!
So how did this happen? Those who know about what can happen in high-debt countries might be tempted to assume that the British simply inflated the debt away. After all, the UK has a (somewhat undeserved) reputation for inflation. But in fact, over the one hundred years between 1815 and 1914 the price level DROPPED by almost 25%. Sure, there were some years when inflation was positive (in fact 51 of the 100 years had positive inflation), but overall the average annual rate of inflation was just over -0.2%. So that’s not how they did it…..
There are a number of factors involved in how they did it. But suffice it to highlight three for the moment in this post:
1] In real terms (after deflation) the debt actually increased by 16%. But the nominal amount of debt outstanding (which is what concerns us) did not change a whole lot, dropping a mere 10% between 1815 and 1913: GDP growth did the rest.
2] The long-term government bond yield for the 100 years averaged 3.18%, which means that average interest paid by the UK on its national debt during that period was somewhere between 3% and 4% (one calculation would put it at 3.6%); and the interest burden peaked at 9.3% of GDP before gently collapsing to 0.8% by 1913 (the last time that it has been below 1%).
3] The major source of government revenues shifted from duties and tariffs (on goods) to income and consumption taxes.
But the purpose of this post is NOT to explain just HOW the Victorians managed their huge debt burden down to such a low level while maintaining good growth and low (to negative) inflation, but simply to point out THAT they did do it. Which itself simply highlights the fact that a high debt/GDP rate is not necessarily the most urgent priority when facing a long-term growth trough… as is the case in so many western countries at the moment.
I have noted that the period we have been looking at was one of protracted deflation, yet we are told these days (and I tend to agree) that deflation is to be avoided at all costs: so how come it worked out for the Victorians? Well that’s a whole other story… and a whole other post.
So the next time that someone tells you that a high debt level is an impediment to growth, ask them to explain what happened during the reign of good Queen Victoria….
©Copyright Chris Golden June 2013