What are the downsides of being a debt-free country (no foreign national debt)?

Question

I was only a child when the Romanian dictator, Ceaușescu announced that all of the country's foreign debt had been paid:

Romanian leader Nicolae Ceausescu announced this week that his country, despite an economy that a recent U.S. congressional report called the second poorest in Europe, has paid off all of its foreign debts ahead of schedule.

As the same article mentions, achieving this came at a tremendous cost for the population, the most notorious step being food rationing (since almost everything was exported to get dollars):

The costs of this accelerated repayment program have been massive. In a recent report on Romanian human rights violations, congressional Helsinki Commission chairmen Rep. Steny H. Hoyer (D-Md.) and Sen. Dennis DeConcini (D-Ariz.)

I have checked if there are any countries that are debt-free and I could find about five:

Macao, The British Virgin Islands, Palau, Liechtenstein, Brunei

So being a debt-free state is clearly an exception and they probably account for a very tiny fraction of the world economy (all these states have small economies).

From the myopic perspective of an individual, being debt-free sounds something desirable, but I assume that states work differently. I am wondering about the downsides of being debt-free state, assuming this is achieved in a much more sustainable way than Romania's case.

Question: What are the downsides of being a debt-free country (no foreign national debt)?

Answer 1

Eliminating national debt is not necessarily a good thing because a country's economics are a lot less like personal finance and far more like business finance.

Businesses (and countries) take on debt because they believe they can use the debt to spark growth far in excess of the interest on the debt. That's why using a personal frame of reference is usually a bad way of looking at government finance. Personal Debt is usually a bad thing, because a person obtains their money through a salary that's generally independent of their personal expenditures. If I go out and buy a new TV or PS4, that's not going to typically increase my salary.

But businesses (and countries) need capital investments - buying things like supplies/inputs, machinery, staffing, marketing, etc. And realistically, if it can spend X amount of money to turn around and generate X+10% revenue, it's worth taking on a smaller percentage of debt to get that X.

Answer 2

Looking at both pros and cons:
For countries (and partially for individuals), debt is not a problem if the debt (and interest) you accrue today result in higher income than both combined tomorrow. As a simplified example for an individual, you take up a loan of a million euros at 2% p.a. and while paying it off you make 4% profit p.a., so you come out with a net win at the end.

Being debt free has the advantage that you have less risk. In the above example, if the 4% profit you expected instead turned out to be 0.4%, you still have to pay the interest and so lose money, which for an individual can lead to bankruptcy. For countries, the higher the debt-to-GDP ratio and interest on existing debt, the higher the risk that a failed investment will spiral to either bankruptcy, higher debt-to-GDP ratio or higher interest rates for future debt, the last two of which increase the future risk even more.

That means that paying off the debt will decrease the dependency on continuous growth to finance the old debt, but also removes the opportunity to use the money from those debts for further growth.

It can be argued both ways whether the risk of debt outweighs the benefits in the long term or the other way around and I don't think there is a definite answer.

Answer 3

For the rest of the economy, it is useful to have government bonds as a baseline investment. They are presumed to be safer than what one can get by loaning to companies or banks or buying shares. (In a healthy market, they would have lower interest. There is no risk-free profit.)

Young people with a long time to go to retirement should have high-risk, high-gain portfolios if they save for their future, older people closer to retirement should have low-risk, low-gain portfolios. Government bonds are an useful part of such a portfolio.

Answer 4

If governments didn't finance themselves with debt, they would have to get funds from current income (or draw down reserves which obviously not sustainable), or seek external plunder. This leaves them weak in several areas:

• Tax receipts are not smoothed over the year so they might have to wait before spending and miss out on opportunities or worse, be unable to respond to a crisis.
• When the economy slumps, tax receipts slump too, leading to recession.
• Unable to engage in large scale infrastructure developments that are too risky or complex to undertake privately, yet are necessary for overall development.
• Potential to "run out of cash" and lead to loss of reputation and unrest.
• Puts them in strategically weak positions in negotiations.
• War is a risky endeavour, and seldom profitable (for the nation).

The process of becoming debt-free has the obvious consequence: you are taxing more than you are spending. Especially when this happens quickly, it means citizens are getting palpably less back than they put in and makes them even more resentful of paying taxes. In addition, captial resources become run down (or sold) and the status of the whole nation suffers.

Answer 5

Depending on how trustworthy the economy of a certain country is, you might miss out on a lot of money in the current negative interest setting. For example the bonds that Germany is issuing all have a negative interest rate, because investors want to store their capital save. This leads to the situation that Germany is paid extra to make debt.

Link to German newspaper.

Answer 6

Singapore regularly runs budget surpluses, but they still issued debt, for several reasons:

The Singapore Government operates a balanced budget policy and often enjoys budget surpluses. It does not need to fund its expenditure by issuing bonds to borrow money.

The Government issues SGS bonds and T-bills primarily to:

• Build a liquid SGS market to provide a robust government yield curve, which serves as a benchmark for the corporate debt market.
• Grow an active secondary market, both for cash transactions and derivatives, to enable efficient risk management.
• Encourage issuers and investors, both domestic and international, to participate in the Singapore bond market.

Answer 7

The answer to this question depends on the country's ability to roll over debt by selling new bonds.

National debt is a promise of payment by future tax payers. In practice, for most countries, the funds for payment come from new bonds instead. Tax payers are only on the hook if the government cannot find someone to buy new bonds.

If the bond rating is good, that normally is not an issue, but if the bond rating is bad (I'll bet the dictatorship in your example had a bad bond rating) and nobody wants the bonds, then it falls on the tax payer to repay.

The advantage to being debt free is that there is no risk that the tax payers will ever have to pay out. How big that advantage is depends on the risk of investor flight.

Answer 8

Question: What are the downsides of being a debt-free country (no foreign national debt)?

The downsides are plainly that you are missing out in the here and now on "stuff" that you could have now and pay for in the future (or rather have future citizens pay in part). Arguably, investments,e.g. in infrastructure, education etc., today can lead to a bigger return of investment tomorrow, that will make it far easier to pay for the original investment - so easy that you might have a net benefit compared to staying debt-free.

As an extreme example: If your population is about to die from starvation, yet you can buy food for them to survive by taking on debt, the trade off is: a) your nation will survive but have some debt vs. b) your nation will not survive. Typically a) will be considered more worthwhile, both socially/politically as well as economically (a population that survives can produce something after all).

In this sense, taking on debt is always betting that your investment leads to enough improvement of your situation that you will be better off in the future - so much, that the added interest is negligible. Note that the understanding of "better off" might not be purely economical, it might also be a political evaluation. For instance, buying back a portion of what belonged to your country once might be a major political goal that is economically not feasible, but can be done by taking on debt.

Nations as businesses (and in some sense persons) can be considered to be in competition, thus one typical incentive to take on debt to invest in some area, is because your competitor does the same and you want to be at least as good in that area, say military warfare, as them, so you do the same. So the negative impact to be debt-free can be extinction on the very extreme, but typically would be argued to just be so disadvantageous that taking on debt makes sense.

As no one can see into the future, taking on debt always is some sort of a gamble - hopefully at least backed by some insights that give you good chances to win this gamble.

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Side question that came up in the comments: Are National debt like business debts or personal debts?

They are both and neither.

People that are against countries taking on debt typically argue that you don't do that personally (well, some people do, but in many countries it is seen as something dangerous or even a weakness associated with blind consumerism). People that argue for nations taking on debts, often argue that nations are more like businesses and businesses do take on debt. The reality is, both is true and both is not an argument.

The truth is that the way debt works is always the same; for a person, a business and a nation. However, the evaluation and the context can be different:

1. A single person likely cannot take on much debt before being overwhelmed by it, a business and a nation can typically take on much more and they can arguably deal with it over a longer time-span.
2. For personal debt, only the debtor is directly affected, for business debt only the owner and the workers and for a nation the whole nation. Personal defaulting can be pretty devastating, whereas a business defaulting isn't hitting individuals as hard typically (workers can find other work in a healthy economic environment). A nation similarly has no single person to take the fall (yes the prime minister and such, but they don't have to pay the bill personally much more than any other citizen). However, when a nation has to default it can be pretty devastating for every citizen.

So from that perspective, nations are somewhere in-between personal debtors and businesses - they are typically more powerful than persons and most businesses, have additional means to work with debt (influence at national/currency banks, law giving power etc.), but every citizen is a debtor and a defaulting can have massive consequences. Not taking on debt and falling behind against competitors can have massive consequences too however for nations (and their citizens).

Answer 9

Taking on debt means you can buy things now, and pay for them later. Tanks, planes, schools, hospital, paychecks of your employees... Very nice things, maybe things you can't afford right now. But if you take a loan, you can deal with it later. Eventually you will have to pay up, but by then maybe you can take a new loan, or maybe the economy will improve. Most likely you personally won't be around, and someone else will be in charge of the country. But you will get all the credit for the schools, hospitals, paychecks and tanks that your successor has to foot the bill for. Who knows, maybe the country will collapse by then or go bankrupt, and nobody will have to pay the debt after all.

This is what you lose: The ability to buy things. It is very similar to always stashing half your money in a hole and only letting yourself spend the other half. What are the downsides to spending less money? Well, you get fewer nice things. It's the same for countries.

Sure, if you use debt to pay for things, there will be interest, but then again the fact that you get to buy some thing now, rather than later, also represents some time-value which may or may not outweigh the interest. Paying your army this month so they don't revolt sure sounds better than having to pay an extra 10% or whatever in interest, doesn't it?

Debt is basically a source of capital. It can provide tremendous amounts of money, which allow countries to do all sorts of useful things. This is why in some situations debt is called "leverage". Yes, you need to service the debt (interest, etc.) but the servicing is not necessarily exorbitant, and the gain from obtaining capital is often greater. In fact, interest rates are adjusted such that loans are not a ripoff, otherwise nobody would be taking loans and the creditors would not be able to make money.

From the myopic perspective of an individual, being debt-free sounds something desirable

You haven't adequately justified this perspective. In fact, in many cases it is to the individuals advantage to take on debt, even if they have money. If a credit card offers 0% introductory APR, you're better off buying everything on that card without paying it, and investing the money for a year. If a dealership offers you a 0% 6-year loan on a car you want, it's better to buy it on credit and again, invest the money, or keep it around for an emergency. Often, you are far better off getting a mortgage rather than trying to save up hundreds of thousands while also paying rent.

If the individual is extremely disorganized, and forgets to pay bills, doesn't care to take 5 minutes to set up autopay for his car loan, does not understand that credit must be paid back and maxes out his $50k credit card when his income is only $3k/mo, of course this individual should not take on debt. The individual would be less financially efficient with this debt-free lifestyle, but it will minimize the risk from their own lack of organization. Countries typically do not have such pervasive inability to remember paying the bills.

If the individual is unable to plan ahead, and the thought of paying some large some several years later fills him with dread, even though he could easily save a small part of it every month, because he lacks the ability to plan long term, this individual should not take loans - they will generate needless stress and the additional funds won't be worth it. But countries also do't often have such problems with stress or planning.

Moreover, countries, unlike individuals, can always print money (although that devalues their currency and has pretty much the same effect as taking a loan). Countries, unlike individuals, can unilaterally void their obligations by leveraging their military or diplomatic power.

Also, often loans between countries come with strings attached, and the loan-giver gets some amount of control over the taker. A lot of countries like this sort of thing, as it provides them with yet another means of dominating smaller countries without having to do more aggressive actions. The smaller country can in turn feel safe from being seen as a threat, given the financial relationships. A country which goes out of its way to refuse taking on debt, can be seen as one which is too independent, and should be suppressed through military means. So for countries, unlike individuals, being debt-free has an additional downside of making them look suspicious and dangerous.

Answer 10

One additional factor not previously mentioned in earlier answers is that the existence of a government debt market helps support the international value of the country's currency.

One driver of currency trades is the desire - or anticipated future desire - of investment banks to buy assets using that currency. As a result, the presence of a "safe" and nearly liquid investment security that is denominated in the national currency encourages investors to hold that currency.

Answer 11

You might find it helpful to look at the history of (A) the gold standard (B) managed exchange rates and (C) floating exchange rates.

Under the gold standard (currencies hard-pegged to quantities of gold) governments had a limited ability to increase the money supply or take on debt beyond the level where people began to suspect difficulty in maintaing repayments. This would lead to a run on the currency (a bit like a bank-run) and an outflow of gold putting reserves under threat. Sometimes this would lead to exchange controls to prevent this, but this obviously hurt international investment etc. This limited government's ability to issue unsustainable debt but also rendered them less able to manage downturns with increased counter-cyclical spending.

For this reason post-WW2 the western economies shifted to a pegged system (documented in the Bretton-Woods agreement where there were agreed exchange rates but without the hard tie to gold. This increased their ability to issue debt but do too much and you would have a balance of payments crisis and pressure on the exchange rate. This might be resolved by a revaluation but was considered politically and economically problematic. It was also tied to personal exchange controls - there was for example a limit on how much currency you could take with you on a foreign holiday.

Because inflationatry pressures in the 1970s this became unsustainable and 'pegs' were loosened - sometimes 'crawling pegs', exchange rate bands etc. But in the 1980s the shift as completed to un-managed exchange rates set by the currency markets. While this process removed balance of payments crises it replaced them with potential currency depreciation that made clear how much poorer a country was getting!

How does this relate to debt? The relaxation did allow countries more freedom to issue debt, for good or ill. And since that time countries have tended to run permanent deficits. If the amount of debt remains a stable % of GDP you can argue it is reasonalbe financial management, bringing in capital to fund longer term investment. But often it has enable countries to fund unfordable current spending for political popularity at the expense of promising future repayment that may never come. Take it too far and you end up in an inflation spiral.

In short some degree of debt can have a legitimate role but incontinent issuing of debt came be appealing short term but extremely damaging long term.

A happy medium managed by responsible politicians engaged with an informed population is the way to go. As in most things!

Answer 12

In normal environment there are no downsides, since it is very unlikely that government can invest the borrowed money in a way that is more beneficial than just not borrowing it.

As a rule governments borrow money because voters are not smart enough to realize that "free stuff" they get is bought with borrowed money. In other words: it is much easier politically for US government to borrow 100 billion than to raise taxes by 100 billion.

In the current environment where central banks are monetizing government debts to not issue debt is stupid because citizens suffer the burden of inflation, but they do not get the benefits(because they are funding the debt monetization of other country debts).

Answer 13

All the reasons to be debt free as an individual apply to debt free as a country. The positive effects are enormous. These effects will nearly always eclipse any benefit debt has.

However, the US gained significant debt during WWII. If we had not incurred the debt the war would have dragged out many more years and possibly been lost. There was no way to meet the threat without massive spending and incurring massive debt. The faster the war ended the better for the whole world. Debt made the prosecution of the war possible. More debt meant we got the war done faster with far less human misery. Once the war ended, getting out of debt should have been a very high priority.

Most other government debt gives significantly smaller returns in comparison to the benefits that being debt free offers.