For most of my career, government debt has been treated as a problem to be managed.
Politicians talked about balancing budgets. Treasurer speeches revolved around surpluses. Credit rating agencies mattered. Governments that overspent were expected to pay a political price.
Today, that seems almost quaint. The developed world is carrying debt levels that would have been considered alarming twenty years ago.
Yet debt barely rates a mention during most elections. The question for investors is whether debt has genuinely stopped mattering, or whether we're simply in another part of a familiar cycle.
Historical Fiscal Policy vs. Modern Developed World Debt
Before the Global Financial Crisis, fiscal discipline was considered a virtue. Governments that ran persistent deficits were criticised. Balanced budgets were viewed as evidence of competent economic management.
That all changed after 2008.
When economies faced crisis, governments discovered that voters were far more concerned about unemployment and growth than debt ratios. Large deficits became politically acceptable if they helped cushion economic pain.
COVID accelerated this trend dramatically.
Governments around the world borrowed heavily to keep households afloat, support businesses and prevent economic collapse. The response worked in the sense that most developed economies avoided depression-level outcomes. But it came at a significant cost, with public debt ratios jumping sharply across most major economies.
The political lesson was clear: voters rewarded governments for spending during a crisis and showed little concern about how the bill would eventually be paid.
Why Political Incentives Prioritize Deficit Spending Over Fiscal Discipline
Part of the answer is simple incentives. The benefits of government spending are immediate and visible. The costs are often delayed and dispersed.
A new infrastructure program creates jobs today. A support package provides relief now. Debt servicing costs, by contrast, emerge gradually and may not become significant until years later.
Politicians operate on election cycles. Debt operates on much longer cycles. There is also the collective action problem. If every major country is running large deficits, no individual government stands out as fiscally irresponsible.
The United States is running large deficits. Europe is borrowing more. China continues to accumulate debt. Japan has carried very high government debt for decades. When everyone is breaching the old rules, breaching them no longer attracts much attention.
The result is that debt has largely disappeared as a political issue in many countries.
How Government Borrowing Impacts Voter Priorities and Inflation Concerns
This is where things become more interesting. Politicians may believe voters no longer care about debt, but the evidence is more nuanced.
Most people express concern about government debt, deficits and fiscal management. Many also associate rising debt with inflation, higher interest rates and a higher cost of living. The problem is that debt is usually an abstract concern.
Voters may dislike rising debt in principle, but when confronted with specific spending programs, the political calculation changes. People tend to support spending that benefits them directly while simultaneously expressing concern about overall debt levels.
Debt matters until something else matters more. And over the past fifteen years, there has always been something else. The GFC. COVID. Cost-of-living pressures. Housing affordability. Energy prices. Geopolitical uncertainty.
Debt concerns keep getting pushed down the priority list.
The Link Between Sovereign Debt, Monetary Policy, and Inflation Rates
The strongest argument that debt still matters is inflation.
One of the defining debates of the past few years has been whether the inflation surge following COVID was primarily caused by supply chain disruptions, monetary policy or fiscal stimulus.
The answer is probably some combination of all three.
What is difficult to dispute is that governments injected enormous amounts of money into economies through deficit-funded spending programs. At the same time, central banks maintained extraordinarily loose monetary conditions. The combination generated a powerful boost to demand.
For many years, governments appeared to receive a ‘free lunch’. They could borrow more without triggering inflation. COVID suggested there may in fact be limits.
Once inflation emerges, debt becomes harder to ignore because the consequences become visible. Households experience higher food prices, mortgage costs and energy bills. What was previously an abstract fiscal issue becomes a personal financial issue.
Rising Interest Rates and Their Impact on Debt Servicing Costs
Perhaps the biggest reason investors should still care about debt is that interest rates are no longer near zero.
For much of the 2010s, governments could borrow at extraordinarily low rates. This created the impression that debt levels were largely irrelevant.
That assumption becomes less comfortable when borrowing costs rise. Higher debt combined with higher interest rates means governments must devote a larger share of revenue to servicing existing obligations. Resources that could have been spent elsewhere begin flowing to interest payments instead.
That doesn't create a crisis overnight. But it does slowly reduce flexibility. Governments become less able to respond to future recessions, emergencies or economic shocks.
What Changing Fiscal Cycles Mean for Portfolio Management and Market Outlook
The most important lesson for investors is that attitudes toward debt are cyclical. There have been periods when debt was a dominant political issue and periods when nobody cared. We are currently closer to the latter.
History suggests that won't last forever. Debt rarely becomes a problem gradually. It becomes a problem suddenly, after years of being ignored.
Markets tend to tolerate rising debt until they don't. Voters tend to overlook deficits until inflation, interest rates or economic growth force the issue back into focus. The political penalty for debt may have disappeared for now.
But investors should be careful about assuming it has disappeared permanently. The lesson of financial history is that fiscal discipline goes in and out of fashion. The underlying arithmetic does not.
Eventually, every dollar borrowed has to be funded, refinanced or inflated away.
Politics can ignore that reality for a surprisingly long time. But it cannot ignore it forever.
Want to understand how these long-term economic forces could shape your portfolio? At Nucleus Wealth, we spend our time analysing the economic trends that matter beneath the headlines. If you want to discuss how rising government debt and shifting interest rates impact your long-term wealth strategy, book a meeting to talk to our team today.
