Public Debt and the Arithmetic of Time

Public debt, in its modern, institutionalized form, emerges in late 17th-century England. States had borrowed before—Italian city-states, for centuries—but this is the moment sovereign credit becomes stable, credible, and tradable on broad markets. To fund the war against the Sun King, Louis XIV, William III looks beyond taxes. He turns to capital markets.

The problem is one of memory. Just twenty years earlier, the English crown had defaulted on London goldsmiths—who, in a world without central banks or formal regulation, acted as de facto bankers.

The solution comes from an unexpected source. William Paterson, a Scottish merchant, proposes a simple, clever idea: don’t borrow from a handful of wealthy lenders. Borrow from many smaller ones instead. The savings of merchants, the petty bourgeoisie, landowners—ordinary investors—become the source of funding. This gives birth to the Bank of England, a joint-stock company partly owned by the government, tasked with managing and guaranteeing the loan.

The first government securities are hybrids: fixed interest plus a form of institutional participation in the new “company.” Sovereign credit no longer depends on a small circle of bankers. Instead, it aggregates many smaller creditors, investing commercial or productivity surpluses. The crown benefits twice: lower interest and recurring access to finance. From this arrangement, Treasury bills emerge, slowly becoming a staple of modern economies.

Today, sovereign credit is everywhere. Questioning its existence feels almost frivolous. Mainstream economics treats the state as a benevolent planner, a responsible manager using debt to smooth cycles and fund productive investments. Elegant. Optimistic.

Reality is harsher. Every increase in public debt guarantees a larger sum owed in the future, thanks to compounding interest. If loans fund public projects whose returns exceed the cost of financing, and if they’re fully amortized, borrowing can be justified. But global trends tell a different story. Public debt relative to GDP keeps climbing in most countries, like a snowball rolling downhill.

In an ideal world, rising debt might signal constant investment in profitable projects, financed via capital markets because tax revenue isn’t enough. But structural deficits persist across developed economies for decades. More likely, debt grows because returns fall short of financing costs, and maturing loans are refinanced with new ones. Interest compounds. Debt rises. Not to fund growth, but to avoid default.

What are the options? Raise taxes or refinance. Taxes hit the standard of living for those who don’t hold government securities but attack the problem at its root. Refinancing pushes costs into the future. The total sum owed increases, until markets declare debt unsustainable. Default stops being theoretical.

This mechanism allows today’s generation to consume beyond the economy’s real capacity, passing the bill—and interest—to the future. Some of those taxpayers aren’t even born yet, which conveniently reduces political pressure to act. The idea that fiscal burdens will ease over time collapses when debt growth consistently outpaces revenue. In the U.S., public debt has multiplied over the last fifty years, while median income lags far behind.

Yes, some spending funds public goods: hospitals, security, defense. Their returns are hard to measure and depend on social preferences. Spillovers exist. Better healthcare can boost productivity. Growth can increase the tax base. But when these investments are funded through persistent deficits, the message is clear: society is consuming more than it can afford, leaving costs for posterity.

Finance students are told sovereign bonds are “risk-free.” In developed economies, default is rare. Treasury balances are managed responsibly. True—but incomplete. Implicit debt renegotiation via inflation is a hidden default. Policies like QE can erode bondholders’ purchasing power. If unanticipated, inflation hits not just institutional investors and pension funds, but ordinary savers. It’s a future debt amnesty paid by past savers.

The consequence: loss of trust. To attract new creditors, governments must raise rates—to compensate for inflation and to cover higher risk premiums. Once expectations are betrayed, the chance of a classic default rises.

Two explanations help us understand why public debt persists. First, Keynes: “In the long run, we are all dead.” Today’s beneficiaries are not necessarily tomorrow’s payers. Deferring payment creates moral hazard. Ricardian equivalence only works if debt is repaid within a generation, or if people care as much for future generations as themselves. Unrealistic.

Second, Mancur Olson’s “stationary bandit.” The state controls coercion, but governments are temporary. Facing uncertain reelection, they maximize short-term gain. Spending rises. Debt accumulates. Costs fall to future administrations, possibly from other parties. Public debt becomes structural, not exceptional - a natural product of political logic.