We're Borrowing Like Mad. Can the U.S. Pay It Back?

We're Borrowing Like Mad. Can the U.S. Pay It Back? By Greg Ip

Sunday, January 11, 2009; B01


In its battle against the financial crisis, the U.S. government has extended its full faith and credit to an ever-growing swath of the private sector: first homeowners, then banks, now car companies. Soon, President-elect Barack Obama will put the government credit card to work with a massive fiscal boost for the economy. Necessary as these steps are, they raise a worry of their own: Can the United States pay the money back?

The notion seems absurd: Banana republics default, not the world's biggest, richest economy, right? The United States has unparalleled wealth, a stable legal tradition, responsible macroeconomic policies and a top-notch, triple-A credit rating. U.S. Treasury bonds are routinely called "risk-free," and the United States has the unique privilege of borrowing in the currency that other countries like to hold as foreign-exchange reserves.

Yes, default is unlikely. But it is no longer unthinkable. Thanks to the advent of credit derivatives -- financial contracts that allow investors to speculate on or protect against default -- we can now observe how likely global markets think it is that Uncle Sam will renege on America's mounting debts. Last week, markets pegged the probability of a U.S. default at 6 percent over the next 10 years, compared with just 1 percent a year ago. For technical reasons, this is not a precise reading of investors' views. Nonetheless, the trend is real, and it is grounded in some pretty fundamental concerns.

The most important is the coming surge in the federal debt. At the end of the last fiscal year, in September, the total public debt held by the American people (excluding debt issued to the Social Security Trust Fund or held by the Federal Reserve) stood at $5.8 trillion, or 41 percent of gross domestic product -- about what the debt-to-GDP ratio has averaged since 1956. But the Congressional Budget Office projects deficits of $1.9 trillion over the next two years. Add almost $800 billion of stimulus spending, and U.S. debt soars to 60 percent of GDP by 2010 -- the highest level since the early 1950s, when the nation was working off its World War II and Korean War debts.

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So what's the moral of the story? The Obama administration should not focus on debt reduction now, which could actually undermine the prospects for a recovery in the real economy. With households and businesses trying to spend less and save more, the federal government must spend more and save less -- that is, borrow more -- in order to prevent a self-feeding downward spiral in economic activity. Once the recession is over, getting our debt burdens down will hinge on Obama's and Congress's willingness to confront the looming cost of Social Security and Medicare benefits for the aging U.S. population.

The chances of default remain pretty remote. But remote does not mean impossible. The best way to keep those chances remote is for policymakers to vow to get the deficit down once the recession is over -- and mean it.

- rest at www.washingtonpost.com/wp-dyn/content/article/2009/01/09/AR2009010902325_pf.html