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Asset managers and the secrets of the magic money tree

By Anthony Rowley   
September 8, 2023

What should asset managers make of the bold and controversial statement by Harvard economist Paul Sheard in his recently published book The Power of Money that "government debt never has to be repaid?" Does it imply that government bonds can never be redeemed whatever their maturity?

Treasuries or "gilts" and other government debt securities are of course continually rolled over and there are such things as perpetual bonds, but the claim by Sheard (former vice chairman of S&P Global) appears to give governments carte blanche to go into limitless and endless debt.

He rejects the claim that government debt represents a "burden on future generations", which in turn suggests that running up debt is an acceptable thing for governments to do - now and for evermore. A similar claim is made by proponents of Modern Monetary Theory, otherwise known as "magic money tree" advocates.

Government debt, Sheard argues, looks similar to corporate or household debt but is "fundamentally different". The banking reserves (base money) that a government creates when it runs a budget deficit do not have to be repaid any more than do banknotes - provided the government issues debt in its own currency.

This is the "catch" and it effectively limits the ability to create endless debt to those few governments, notably the US, whose currencies enjoy universal acceptance. But this could change as more governments form regional currency arrangements and faith in the dollar erodes.

Money managers and asset managers who need to make regular decisions on the amount and quality of government debt they invest in need to be aware of these developments, as a reading of Sheard's provocative new book makes clear. The landscape of government debt may be about to change.

The fact that this has not happened so far and that the United States is virtually the only country that can run continual budget and external deficits and indulge in regular fiscal brinkmanship (via debt-ceiling crises) is because markets are happy to accept the dollar at face value.

Conventional wisdom holds that the dollar will remain the world's principal trading, investment and reserve currency for the foreseeable future, with the euro as a distant second and currencies like China's RMB relegated to the status of the "also-ran" or the unsuccessful challenger. But conventional wisdom may well be wrong.

Regional currency arrangements of one kind or another (many of them with the RMB as a component) are proliferating, and if members of these are willing to accept each other's currencies that will widen considerably the scope for their governments to issue "non-repayable" debt.

To give just one example, the number of members of the BRICS group (Brazil, Russia, India, China and South Africa) will see their numbers more than double from five to eleven on January 1, 2024, to include oil giants Saudi Arabia, the UAE and Iran, as well as Argentina, Egypt and Ethiopia.

Bringing the three oil majors into the fold may appear to be mainly a move by the BRICS countries to ensure future energy security among the grouping despite founder members China and Russia also being significant producers. But it is also about an evolving BRICS financial and economic strategy.

This aspect of global power projection is not always appreciated in assessments of why Asian and other emerging economies such as China place great store by having their currencies achieve international status. It is not just a matter of prestige or trade and investment convenience.

Governments need to finance not only areas like health, welfare, education and other domestic spending but also defence and military power projection as well as international development spending on infrastructure and foreign aid.

Sheard's book explains the mystery of how money is created in the first place through bank loans and government deficits rather than deposits. It gets good reviews from experts like former US Treasury Secretary Larry Summers and World Economic Forum head Klaus Schwab. But it is not only interesting reading for experts.