How much is the war in Iraq costing us?

What would happen if the federal government goes bankrupt? 
-- Gary R., West Mifflin, Penn.

Bankruptcy usually refers to the process individuals or companies go through when they can’t pay their debts. It’s a legal proceeding that adds up everything you own (your assets) and then uses that money to pay off what you owe (your debts) — or as much as possible. The court ultimately signs off on a plan for who gets what.

Countries don't go bankrupt. For starters, when a country borrows, it often doesn’t promise to use specific assets to pay back the loan. A U.S. Treasury bond, for example, is backed only by the “full faith and credit” of the U.S. government to pay interest and repay the principal when the bond comes due.

Governments can — and occasionally do — default on their debts, and the results aren’t pretty. Though the process often involves a restructuring similar to a bankruptcy proceeding, a default brings immediate — and lasting — economic pain. One of the worst recent cases was the 2002 default by Argentina, which included a steep devaluation of its currency and an unemployment rate that hit 25 percent.

Even before a government gets close to default, investors who believe its finances are a mess demand higher interest payments before they’ll part with their money to buy that government’s bonds. That's how the bond market punishes countries (and companies) that don't manage their finances well: by raising the cost of borrowing.

There is certainly cause for concern about U.S. budget deficits — now running in the hundreds of billions of dollars —  and the looming costs of paying baby boomers’ bills for Social Security and Medicare. But Uncle Sam is a long way from going broke.

Like any retirement plan, for example, Social Security can get off track from time to time, just as it did in the 1980s after a decade of high inflation threw the numbers out of whack. During the Reagan administration, a compromise was reached to make adjustments to taxes and benefits, and the plan was put back on track.

Even at current levels, the U.S. budget deficits are not all that high by historical standards as a percentage of the Gross Domestic Product. Since government borrowing is ultimately paid back with taxes, the size of the economy is a pretty good measure of the government’s ability to raise those taxes. Today, the deficit represents about 3 percent of total U.S. GDP.  By comparison, in 1943, at the height of borrowing to pay the cost of fighting World War II, the deficit came to something like 30 percent of U.S. GDP

So the risk of default is still extremely low — if Congress can get its financial house in order and address the problem. Congress was able to tame its spending habit in the 1990s, and there’s not reason it can’t bring back the “pay as you go” rules that got budget deficits under control. The idea is pretty simple: If you’re going to spend money on something, you have to raise the taxes to pay for it. And if you’re going to cut taxes, you have to find places to cut spending.

While the problem of taming out-of-control government spending is daunting, you have a chance to do something about in the next few weeks. If you haven't already done so, check out the Web sites of candidates for Congress in your area — and vote accordingly.

After all, it's your money.

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