US debt concerns create many questions
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The US government spends more than it takes in, a practice that is illegal in most state governments and harshly criticized when households and businesses do it.
After being the rule rather than the exception for most of the past century, why is the country's deficit spending such a big deal now?
Asked to rate the issue's importance on a one-to-10 scale, Wharton finance professor Franklin Allen says that, unequivocally, "it's a 10. Ultimately, if we don't get rid of the deficit we are going to have some kind of major economic crisis because of the debt."
Most experts say that the US is not on the brink of catastrophe - that it can muddle along for years. But they also agree that a failure to deal with the problem in the long run could undermine investments and economic growth, sparking higher unemployment, weakening US competitiveness and, in general, eroding Americans' quality of life.
Getting the deficit under control "is absolutely vital to our long-term economic health," according to Mark Zandi, chief economist and cofounder of what is now Moody's Economy.com. Failure to do so, he notes, would lead to a serious rise in interest rates, choking economic growth and forcing the government to spend more and more of every tax dollar simply to make payments on past debts...."
The choices, adds Allen, are stark: "If people want the kind of programs that we currently have, they are going to have to pay more in taxes. If they don't want to pay, then they will have their benefits cut."
The deficit is the annual gap between spending and revenue, and the total debt is the result of annual deficits accumulated over the decades.
For the current fiscal year, the deficit is expected to exceed US$1.5 trillion, up from US$459 billion in 2008 and a surplus of about US$128 billion in 2001. The debt now stands just shy of US$14.3 trillion - the current debt limit set by Congress - compared to less than US$8 trillion a decade ago. Among the most pressing issues is whether Congress should raise the debt limit so the government can continue to borrow after the current ceiling is hit in the next few months.
Both the deficit and debt have grown dramatically in recent years, largely as a result of the wars in Iraq and Afghanistan, government stimulus spending during the Great Recession, low tax revenue due to the weak economy and growing spending for entitlements like Medicare, Social Security and the prescription drug program enacted in 2003.
The debt crisis currently faced by a number of European countries has made the importance of the issue very apparent, even to laymen.
And in mid-April, Standard & Poor's, the rating agency, revised its outlook for US government debt to "negative" from "stable," because the country has not come up with a long-term deficit-reduction plan.
Around the same time, Bill Gross, manager of the US$237 billion Pimco Total Return Fund, the world's largest mutual fund, said he had eliminated US Treasuries from his portfolio due to prospects for poor returns. And China, the United States' largest creditor, has indicated it may move to diversify into other forms of debt to reduce risk.
Governments finance deficits by borrowing, which is done by selling government bonds like US Treasuries and then selling new bonds to pay off the old ones, like a consumer shifting debt from one credit card to another.
"What begins to happen is that the interest rate you have to pay starts going up because people begin to worry about whether you are going to pay [the borrowed money] back or not, so they demand a higher return," Allen says. Given the recent experience of some European countries, the danger point seems to come when government bonds begin to yield 6 percent or 7 percent, he notes. The key 10-year US Treasury note currently yields 3.35 percent.
Accounting for debt involves some debate over what should be included, Allen adds. The current debt limit of about US$14.3 trillion equals nearly 100 percent of the United States' gross domestic product, with the critical level thought to be somewhere between 120 percent to 150 percent. But the current ceiling does not include future liabilities for unavoidable expenses like Social Security, Medicare and Medicaid.
With those included, the debt may be somewhere in the US$75 trillion range, or five times GDP, Allen says.
Despite all the worries, the sky has not yet fallen. Interest rates remain remarkably low - in the past, 10-year Treasuries have often yielded upwards of 5 percent.
A number of forces shore up the demand for Treasuries, helping to keep rates low. China, for instance, cannot simply slash its Treasury portfolio because the flood of supply would weaken bond prices, reducing the value of China's remaining holdings.
Kent Smetters, professor of insurance and risk management at Wharton, says investors apparently believe Washington will manage the crisis somehow, since the consequences of not doing so would be dire. US Treasury securities still look safe compared to alternatives like stocks, corporate bonds or government bonds sold by other countries, he adds.
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