What happens if the U.S. borrows too much?

John W. Schoen Senior producer • Profile • E-mail

As Congress and the incoming Obama administration work out the details of a massive economic stimulus plan, some readers are asking: Where is all this money going to come from? How long can we keep up with all this borrowing? And why should my tax dollars be spent to clean up the mess made by other people’s mistakes?

Just how long can the U.S. government sustain all this borrowing and spending? First of all, basic revenues and expenditures are out of balance, generating the large annual federal deficit. Now, we have one or more bailout programs, plus a stimulus package or two; and on top of all that, all the governors want a $1 trillion bailout. How long can this go on?
— Tom Kwiat, Address withheld

The only honest answer: No one knows. For the past few decades, a number of economists, analysts and a few members of Congress have been pressing to balance the federal budget; some have called it a national security issue. During that period, the U.S. economy enjoyed one of its longest economic expansions in history — interrupted by two relatively mild recessions. The takeaway for some: Rising national debt isn’t a problem as long as the economy keeps growing at roughly the same pace.

Proponents of this idea argue that the overall level of debt is less important than its relationship to the size of the U.S. economy. If you’re carrying a $5,000 credit card balance with an annual income of $30,000, your debt load is going to ease considerably if you get a new job that pays $60,000. In fact, you could then double your debt and carry the same load on a percentage basis.

Today, the U.S. national debt is about two-thirds of its gross domestic product. We’ve seen much higher: During World War II, the debt hit 120 percent of GDP.

But when the war was over, defense spending plunged and the economy surged, bringing the ratio back down to 60 percent by the early 1950s. That’s about where it was in the late 1980s and early 1990s before concerted efforts by Congress and the White House balanced the budget and cut that ratio below 60 percent. In the past eight years, heavy tax cuts and spending on the war and prescription drug benefits pushed the percentage back to the mid-60s.

That ration is almost certainly headed higher. On top of the ongoing, multibillion-dollar shortfall between taxes and spending for government services, the congressionally approved bank bailout program will add at least $700 billion to the debt. Now Congress and the White House are considering a plan that would add another $675 billion to $775 billion in relatively short order. That would push the overall national debt closer to 85 percent of GDP.

The gamble is that the economy will begin growing again and the government will recoup some of the borrowed money by selling off assets it is buying in the bank bailout program, bringing the debt-to-GDP level back down to (roughly) currently levels.

AP Jobs, spending data hint at recovery In a hopeful sign for the economy, the number of newly laid-off workers filing claims for unemployment benefits fell below 500,000 last week for the first time since January. New-home sales rise to highest level in a year Consumers log stronger-than-expected rebound Durable goods orders fall unexpectedly Recovery's pace slower than first thought

Even if the bet pays off, there’s a real risk of nasty side effects. For starters, there’s only a certain amount of hard money (savings and investment) around the world for Uncle Sam to borrow. As the U.S. soaks up this cash, there’s less money for businesses to borrow and grow or for homeowners to buy houses. That forces interest rates higher — reversing the stimulus effect the Federal Reserve is trying to engineer with lower rates.

Churning out more debt also increases the amount of dollar-based investments flowing through the global financial system. It’s not exactly the same as printing dollars, but the effect is similar. As the global system is flooded with dollars — and investors start wondering how Uncle Sam is going to pay all this back — the value of the dollar falls.

If it falls a little, that’s not a bad thing — it helps U.S. exporters sell goods overseas. But if the value of the dollar falls too far, so does its purchasing power — even if demand for goods and services remains sluggish during a recession. That’s where inflation comes in. And if you have inflation in a recession, you get stagflation, the disease that left the U.S. economy and stock market in ruins throughout most of the 1970s.

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