A Clean Slate: Debt Jubilees and the Long-Term Debt Cycle
With global debt levels reaching historic highs, you might hear the term "debt jubilee" floating around. It's a dramatic-sounding phrase that essentially means the cancellation of certain debts. While it might sound like a modern, radical idea, it's a concept with a history stretching back thousands of years.
As debt-to-GDP ratios are projected to climb, it's a good time to understand what a debt jubilee is, how these cycles have worked in the past, and what they might look like in our modern financial system.
A 4,000-Year-Old Idea
The idea of forgiving debt isn't new. In ancient societies like Sumer and Babylon, debt was often tied to agriculture. A bad harvest could ruin a farmer, forcing them to lose their land or even enter a period of indentured servitude. When this happened to enough people, it threatened the stability of the entire society.
To prevent widespread unrest and revolution, rulers would periodically decree a "jubilee"—forgiving debts and resetting the economic landscape. It wasn't always about kindness; it was a practical tool to maintain social order and prevent a concentration of wealth so extreme that it sparked violent conflict. From ancient Israelite law to the reforms of Solon in ancient Athens, debt forgiveness has been used as a societal pressure-release valve. These resets aimed to wipe out growing instabilities and begin again with a cleaner slate.
The Long-Term Debt Cycle in Modern Times
Today, we see a modern version of this phenomenon in what's known as the long-term debt cycle. Most of us are familiar with the shorter, 5-10 year business cycle of boom and bust. However, looking at the bigger picture, we can see that over many decades, something else has been happening. With each cycle, total debt in the economy tends to end up higher than before, while interest rates trend lower.
Lower interest rates make it easier to service more debt, so the pile grows. But what happens when interest rates approach zero? There's no more room to cut them to stimulate the economy or make the debt burden more manageable. At this point, the sheer volume of private debt becomes a systemic risk. The system is so leveraged that allowing a wave of defaults isn't an option—it could cause a catastrophic collapse of the entire banking system.
So, when a crisis hits in this environment, governments and central banks step in with massive fiscal spending and monetary support to prop up the system.
The Moment Private Debt Becomes a Public Problem
This intervention effectively transfers the debt problem from the private sector (households and corporations) to the public sector (the government). Think of bailouts, stimulus checks, and relief programs—they all move the burden onto the government's balance sheet.
Once the government is carrying an enormous debt load, it faces its own set of problems. It can't simply default on its obligations if the debt is in its own currency. Instead, the most common path is to "manage" the debt by ensuring interest rates remain below the rate of inflation for an extended period.
This process is a form of slow-motion default. Bondholders are paid back, but the currency they're paid back with has lost purchasing power. In essence, the debt is being devalued through inflation. Holders of cash and bonds are the ones who ultimately absorb the cost of the deleveraging.
The Case of Japan (And Why It’s Unique)
Japan provides a fascinating real-world example of this private-to-public debt shift. After a massive real estate and stock market bubble popped in the early 1990s, Japan entered a multi-decade period of economic stagnation. During this time, the government ran significant deficits, effectively absorbing the private sector's bad debt. Japanese government debt-to-GDP soared to over 260%.
Simultaneously, a massive corporate deleveraging took place. Japanese companies, which were once highly indebted, used the next few decades to repair their balance sheets, accumulating huge cash reserves.
Japan managed this transition without triggering high inflation. But it's crucial to understand the unique conditions that allowed this. Japan has a large current account surplus (it exports more than it imports), is a net creditor to the world, and experienced this during a long period of falling global commodity prices.
Many other developed nations, including the United States, have the opposite profile: structural trade deficits, a negative net international investment position, and are now facing a period of tighter commodity markets. Assuming they can simply follow the Japanese playbook without a more inflationary outcome is a risky assumption.
Why Can’t Central Banks Just Forgive Government Debt?
A common question is, if a country's central bank owns a large portion of its government's debt, why can't it just forgive it and wipe the slate clean?
The answer lies in how a central bank's balance sheet works. A central bank has assets (like the government bonds it owns) and liabilities (the physical currency in circulation and commercial bank reserves held at the central bank). The monetary base is essentially backed by the assets on the central bank's balance sheet.
If the Federal Reserve were to simply "forgive" the trillions in U.S. Treasury bonds it holds, its assets would plummet while its liabilities remained unchanged. This would render it massively insolvent. An insolvent central bank loses all credibility and independence. The trust that underpins the entire fiat currency system would break down. The system is circular: the currency is backed by the government bonds, and the government bonds are supported by the central bank's ability to create currency. You can't just remove a core piece of that loop.
So, How Is Debt Actually Reduced?
While outright forgiveness is a non-starter, there are other ways governments and central banks can manage an insurmountable debt load.
Financial Repression: This is the main method, as discussed earlier. Central banks hold interest rates below the rate of inflation for years, or even decades. This allows inflation to steadily "burn off" the real value of the debt. It's the most subtle and politically palatable solution, though it penalizes savers and bondholders. The 1940s in the U.S., after debt soared to fund World War II, is a classic example of this.
Accounting Maneuvers: It's also possible for governments and central banks to engage in some creative accounting. For instance, a central bank could swap its holdings of short-term government bonds for special, 100-year, zero-coupon bonds. For all practical purposes, that debt is kicked so far down the road it's no longer an immediate concern, but it technically remains on the books, keeping the central bank solvent.
The talking heads have had Government debt as a topic of conversation a LOT recently and I find it relevant to discuss release valves used in the past. When debt levels become this high, the focus often shifts from outright repayment to managing the problem through currency devaluation and financial repression. It's a cycle that has played out many times throughout history, and it has significant implications for the value of money and different types of assets over the long term.