How dangerous is the national debt?

With Congress and the White House at the start of the annual budget battle, Eric in Florida wants to know: How can they keep ignoring the rising pile of national debt? Jim in Illinois is wondering just how much that recent marketing stunt in Boston — the one that backfired when it sparked a massive bomb scare — cost the city and the company behind it. 

Why is it that when people talk about (the U.S. budget), the gross domestic product is brought up and explained that our deficit is at a low level? Why is the national debt -- $8.7 trillion, which climbs at almost $2 billion a day --  never mentioned? Add the (billions) Bush is requesting for Iraq and Afghanistan and we will now top $9 trillion dollars with no end in sight of ever paying this off.
—Eric J. Melbourne, Florida

There’s widespread agreement that the rising national debt is a problem. And since voters seem to have picked up on this issue, you’re going to be hearing more about it from both Republicans and Democrats in Washington, who last week began the annual circus act known as “the budget process.”

But even before the debate got started — over the tough choices involved in raising taxes and/or cutting spending — it turns out Congress and the White House are living in parallel universes where different sets of numbers apply to the federal budget. The White House maintains that even if major tax cuts set to expire in 2010 are left in place, rising tax revenues from a growing economy will produce a surplus of about $150 billion by that year. The Congressional Budget Office, in the other hand, says that if the tax cuts stay the projected surplus vanishes and becomes a $100 billion deficit.

No wonder they can’t balance the budget. But even they do, there’s still that big pile of debt left over from past overspending. So just how dangerous is it?

At $8.7 trillion and counting, your share now comes to about $29,000. Something like 9 cents of every tax dollar goes to pay just the interest, and as the debt rises, so does that interest payment. Think of it as the minimum monthly installment on Uncle Sam’s Mastercard.

That doesn’t sound like it can go on forever. But Uncle Sam has been borrowing money and piling up debt your behalf for decades. Still, the sun comes up every day, and most Americans go to work. Paychecks clear, mortgage payments are made, and a new batch of contestants defies the odds on American Idol. And the repo man never shows up. How can this be?

Let's use your personal finances to put the question in perspective: How big a problem is a $29,000 credit card balance? For most people, that sounds like a lot of money. But it's a bigger problem if you make $30,000 than if you make $300,000.

GDP — the value created by Americans making goods and selling their services — is a rough benchmark for a country's "income." Because tax revenues rise as the GDP grows (assuming no change in tax rates), a growing economy can, in theory, sustain heavier debt loads. So it helps to look at the national debt in relation to GDP as a measure of how well the economy can sustain that debt — just as your paycheck has a lot to do with how much personal debt you can handle.

Currently the national debt is about 66 percent of GDP, which is about $14 trillion a year.

That sounds like a lot. But it was nearly double that at the end of World War II (120 percent of GDP) and remained well above 60 percent for most of the prosperous 1950s.

By 1980, the debt had more than tripled in absolute terms, but it had fallen to 33 percent of GDP. Part of the reason is that GDP soared. But the 1970s was also period of rampant inflation — one of the worst economic cycles in a century. The Great Inflation helped ease the debt load for Uncle Sam: The dollars that made up the GDP were inflated, but the value of the debt wasn't. Unfortunately, inflation also destroyed the savings of anyone who held that Treasury debt, many of whom were retirees on a fixed income who saw their spending power melt away and standard of living drop. (When inflation is out of control, it pays to be a borrower, not a saver.)

High levels of debt have historically presented another problem. If a big borrower — a government or large company — floods the bond market with paper, investors may begin wondering whether they’re going to get their money back. To attract more investors, the borrower usually has to sweeten the deal with higher interest rates. (It's not a lot different than a credit card company charging you higher interest if they see you’re in debt up to your eyeballs.) When rates go up on Treasury debt, that raises the cost of all borrowing. And often slows the economy — because when borrowing costs go up, businesses are less likely to expand and hire more people, which means less widgets are made and fewer burgers flipped, so the GDP doesn’t grow as fast.

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