"Men and nations behave wisely when they have exhausted all other resources."
 

- Abba Eban, Israeli diplomat and politician

 

For a template of what is going on today, consider the three graphs below to see how the United Kingdom "paid" down their debts from 1820 to 1998.

Graph One

 

This is a graph of the UK's Debt to GDP, or more simply debt outstanding divided by the size of the economy. As the graph declines in the years 1820 to 1912, or 1950 to 2000, it does not mean debts went down, just that they went down as a percentage of the economy. As an example, if you are carrying $100,000 of debt and receive an income of $100,000, your debt to GDP ratio is 100%. Now imagine your debts go up to $200,000 but your income rises to $600,000, your debt to GDP ratio is now 33% even though your debts have gone up from $100,000 to $200,000, or basically doubled.

 

Graph Two: 1820 to 1912

 

UK debts decline marginally from just shy of £850 million to just over £600 million, but the debt to GDP mentioned above dropped substantially. Why? The economy (the country’s “income”) increased substantially because of this thing called the Industrial Revolution (read: massive innovation from handmade to machine production); in addition, inflation was well contained with almost no change in price levels over the period, which preserved real wealth.

 

Graph Three: 1948 to 1998

 

While UK debt levels went up by more than an unheard of 10 times in this period, the debt to GDP ratio spiraled down by a factor of 10. How could this happen? Part of the equation again was economic growth and the effect the power of compounding growth has over 50 years. Just think of what a house is worth today compared to 50 years ago, the magnitude of the increase is surprising even if the growth rate of house prices was only 4 to 5% per annum over the five decades. The third contributing factor was the silent tax called inflation. Make no mistake, government leaders like some inflation as they recognize inflated incomes make debts “look” smaller and it also allows for a silent increase in taxes – always a positive for an office holder. Often misunderstood or overlooked is that inflation punished bondholders, who after inflation adjusted rates saw their wealth destroyed in the period by 90%, or more.

Conclusion:

• The story above replays itself over and over through history
   
• Governments do not and never will pay off debts
   
• Government debts will likely be larger in 30 years than they are today as politicians commit to more assistance that increase the debt
   
• Innovation, economic growth and inflation is what "pays" debts off in spite of all the government programs trying to "help" (think of it as a well-meaning neighbour inadvertently trying to put out a house fire with gasoline)
   
• To manage your own financial life, keeping cash for emergencies and your near-term expenditures is a must, but your least risky choice to protect your 10 to 20 year long-term money from the ravages of inflation is to own the best businesses in the world that grow their profits and dividends
   

Randy and Ian

 

Source for all charts: www.historyandpolicy.org, Covid-19 and the UK national debt in historical context