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.
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.
Even if policymakers manage to navigate successfully through the current recession and the trillions in new debt bring the desired economic recovery, this is not a great time to raise the level of debt relative to GDP.
That’s because another multitrillion-dollar bill is coming due — no matter how well the economy recovers. As baby boomers retire and begin making claims on the Social Security and Medicare systems, the government will be forced to borrow heavily to meet those obligations. Unlike the surge that sent debt levels above GDP during World War II, that level of borrowing for decades of Social Security and Medicare payments just isn’t sustainable.
As the problem comes into clearer focus over the coming years, it could get more difficult to convince the rest of the world to lend their money to the U.S. Treasury.
Why should those of us who purchased cars and homes based on our budget have to help out the builders, lenders and people who made commitments they obviously could not afford?
— Don W., Hesperia, Calif.
Because if we don’t, we won’t have an economy to produce more homes and cars for our kids.
No matter who you think is to blame, no matter what you think about the importance of letting businesses and people fail, we’re past the point where that debate matters much. There will plenty of time for that later — after the economy is stabilized. At the moment, there are few signs that’s happening.
The hope is that the government’s massive intervention can break a downward spiral that shows no signs of letting up in the short term. Falling house and stock prices have destroyed trillions of dollars of wealth, which has forced companies and consumers to cut back. Those job losses have further cut into spending and home buying, which is bringing more layoffs.
So far, trillions of dollars have been dropped on the economy by the Federal Reserve. The Treasury has pumped $350 billion in taxpayer funds into the banking system. And Congress and the incoming Obama administration are prepping a massive spending package to fill in the gap created by the shutdown of consumer spending.
In the midst of all this, we’re getting a bonus: Crashing oil prices have slashed prices at the gas pump. That’s freed up an estimated $250 billion in consumer spending power. Every hundred billion helps.
This flood of money will take time to work its way through the system; some of these programs will work more quickly than others. The Fed’s effort to push mortgage rates lower is barely under way, and rates already have fallen sharply. On the other hand, there’s evidence that banks are hanging on to much of the money they have received.
It all goes well, these measures should begin to have the desired impact by the middle of next year. A lot, though, can go wrong.
On top of the list is a new surge in foreclosures that is just now getting under way and expected to continue through next year unless something can be done to prevent it. As long as lenders keep dumping houses on the market at distressed prices, more home equity will be destroyed for all homeowners, spending will continue to shrink, jobs will be lost and the economy will remain in its downward spiral.