Spiralling national debts may well result in many years of high inflation

This solution to debt seems unlikely to be repeated. Firstly, having sold off assets like Telstra, the Commonwealth Bank, and much of the electricity industry, there are few obvious candidates remaining for potential sale. Secondly, given politicians' appetite for spending and for staying in power, the will for further increases in taxes or major cuts to spending does not seem to be there. Cost-cutting budgets would also leave little room for conservative governments in Australia to push pet causes like defence spending or assistance to private schools, should they get elected.

The other avenue to reducing national debts is to use the same methods that were used in the post-war period to dramatically reduce debt. Britain's post-war experience (partly copied by other countries) is a classic case in point.

During the 1930s Britain's debts were already high, reflecting residual debt from the First World War and costs associated with the Great Depression. The cost of WW2, however, meant that by 1946 Britain's public debt had reached 2.3 times income.

Wartime controls ensured that the yield on government bonds was kept low. For public debt to remain manageable interest rates needed to be kept down for a prolonged period. This was done by continuing controls on capital issues, credit and foreign exchange through the 1950s. Full liberalisation of the capital account of the balance of payments did not occur in the UK until as late as 1979.

The most important factor in the shrinking burden of the debt was 7 per cent annual inflation, which eroded debt in real terms. Negative real rates of interest effectively ensured that bondholders bore the brunt of debt reduction. Interest transfers from taxpayers to bondholders in the post-war period ended up being limited to no more than 6 per cent of national income. Bondholders, who originally paid for the second world war and expected their money back afterwards, ended up with an unexpectedly large share of the final bill.

Britain's public debt had the side effect of depressing economic growth, which in the 1950s and 1960s was disappointing compared with its European neighbours. At the same time, Britains ratio of public debt to GDP fell from 2.3 times national income in 1946 to just 34 per cent in 1991.

Of the vast debts Britain had accumulated during the Second World War, one-third of the total £3.5 billion was owed to British India. During the War, India acted as a supply base, resulting in a large trade surplus with Britain, which was credited to India in sterling loans. The requisitioning of Indian resources (especially food) for the war effort was extensive and, despite warning it could result in famine, the British opted to continue exporting rice from India to meet military and other needs. A result was that a major famine resulted, especially in Bengal, around 1943.

By December 1945, these balances peaked around £1.3 billion. A resolution to the outstanding 'sterling balances' was a priority for both leading Indian anti-colonial political parties, and for the U.S. Treasury (another major creditor). The 1947 Financial Agreement recognised a debt to India of about £1.16 billion. Following the partition of India, a portion was transferred to Pakistan.

The British Government would only agree to the slow release of these funds in order to manage Britain's balance of payments. The 30 per cent devaluation of the pound in 1949 significantly reduced the purchasing power of the remaining balances, causing economic difficulties for India. The decline in the value of sterling and high rates of inflation allowed Britain to reduce its debt burden over time at the expense of its creditors.

In today's capital markets, it is a lot more difficult for governments to control yields or monopolise the world's savings, though it may be expedient to move to an era of more controls. In the case of the US, whose dollar has been used as a reserve currency, this role would be threatened by an era of high domestic inflation.

Experience indicates that it is hard to reduce debt in times of deflation and depression. If debt is not cancelled, it must be either repaid or inflated away. There will be a strong temptation for some countries to adopt the latter option.