But start to miss those and the banks will slash your credit, bombard you with phone calls, and turn the collection agencies loose on you.
So who is Uncle Sam’s collection agency? And what, exactly, will trigger the ruinous debt crisis that many economists say is coming?
Those are surprisingly hard questions to answer. In some ways, the U.S. government is like the world’s biggest, most indebted consumer, borrowing from lenders all over the world to finance about 43 per cent of its spending this year—Washington’s biggest borrowing binge since World War II. But Uncle Sam is also Sui generis, because it’s so big it can’t possibly be treated like an ordinary borrower. Even a hint that the United States might default on its debt, a la Greece or Ireland, would produce financial mayhem that would dwarf the shock of 2008. Besides, Washington can always print money to assure it can pay its bills, thanks to the dollar’s enduring role among global investors as the currency of last resort. No other borrower in the world has that luxury.
America’s unique privileges provide more of a cushion than some debt alarmists acknowledge, but they also mask the depth of the problem and allow Washington to get keep piling on debt instead of kicking the habit. The mushrooming national debt, for instance, is now more than $14 trillion, and will soon eclipse the total size of the whole U.S. economy. Yet Washington is actually spending a lower portion of its total budget on interest payments than it has in years, because interest rates are remarkably low. Interest payments on the national debt will cost taxpayers about $210 billion this year, which is less than the cost of interest in every year between 1995 and 2000. Interest payments will account for just 5.4 per cent of federal spending this year, compared to 12.5 per cent in 2000. That’s one reason politicians can get away with blasting hot air about the debt, while doing little or nothing about it.
But that won’t last. Interest rates are nearly certain to rise from their historic lows as the global economy recovers and demand for capital picks up. The White House predicts that by 2015, interest payments on the national debt will balloon to nearly $500 billion, or nearly 12 per cent of all spending. That’s without a debt crisis that could drive rates even higher. And in the “out years” after 2015, America’s debt, on its current course, would begin to consume so much cash that it would suffocate the economy. Here are some of the developments that will signal the problem is no longer theoretical, and is on the verge of becoming a true financial crisis:
Investors begin to shun U.S. government securities. This is already happening, to a limited extent. Investing firm Pimco, the world’s biggest bond trader, recently disclosed that its largest mutual fund, the Pimco Total Return Fund, has reduced its holdings of U.S. government securities from 12 per cent in January to nothing at all. That doesn’t necessarily mean Pimco believes a debt crisis is coming. But it does suggest that Pimco feels the yield on Treasuries is too low given the risk of a default, however marginal that might be. Other investors don’t necessarily agree; overall demand for government securities remains much higher than the supply, which will help keep rates low for now. And concerns about China cashing in the large amount of U.S. debt that it owns are probably overblown, since the export-dependent nation would be harming its biggest customer if it did anything to weaken the U.S. economy.
The signature event of a bona-fide debt crisis is often a “failed” auction in which the government in question can’t sell all the securities it wants to at preferred interest rates, because investors feel the risk of a default justifies a higher rate. But there are usually several precursors to that. “You get a vicious circle in which there’s increased nervousness, then interest rates go up,” says economist Bill Cline of the Peterson Institute for International Economics. “Then the expected accumulation of debt is more rapid, which reinforces concerns about solvency.” Market watchers carefully monitor demand for Treasuries, so if it began to fall significantly, it would be big news.
The economy falters. Policy in Washington is now predicated on a lasting recovery that gradually brings down unemployment. But anybody reading the news knows there’s still a lot that could go wrong, from rising oil and gas prices to an economic slowdown in China to unresolved debt problems in Europe. So far, the economy seems to be withstanding all of that, but if a double-dip recession were to develop, it would mean lower tax revenues for the government, more deficit-funded stimulus spending, and an even bigger national debt. That would accelerate the occurrence of any potential crisis.
Inflation ends up worse than expected. Despite rising gas and food prices, the Federal Reserve still feels inflation is under control, which is one reason it’s continuing its controversial “quantitative easing” program. If inflation ends up higher than expected—due to an oil spike, skyrocketing commodity costs, or something unforeseen—the Fed will face a tough problem. The usual way to combat inflation is by raising interest rates. But that would jack up Uncle Sam’s borrowing costs and weaken the economy, which could be more destabilizing than inflation itself. The Fed has been walking a razor’s edge with its aggressive stimulus efforts, and if its effectiveness seemed to fade while it was still needed, that could produce a confidence crisis.
The cost of insuring against a U.S. default goes up. Many economists think the risk of the U.S. default is effectively zero, since the government can always print money. But there’s still a market for insurance against a U.S. default, through credit-default swaps. These are arcane financial instruments that ordinary people know little about, but if they started to indicate a problem, you’d hear about it. For now, the cost of insuring against a U.S. default is low, but not the lowest in the world. CDS spreads are lower in Switzerland, Sweden, and Finland, for example. In Ireland, however, they’re about 13 times higher. And in Greece, they’re 23 times higher. CDS spread on U.S. debt wouldn’t have to get nearly that high to worry investors; even a gradual uptick would signal growing fears about U.S. solvency.
A ratings downgrade. Rating agencies like Standard & Poor’s, Moody’s, and Fitch grade the quality of debt issued by nations—”sovereigns”—based on how likely they are to pay back the amount borrowed over periods as long as 30 years. The United States currently has the top rating, which allows it to borrow at the lowest rates. But the rating agencies have all signaled concerns, and if America’s credit rating falls, it will push borrowing costs up and probably cause a whole raft of second- and third-tier problems.
Not long ago, Moody’s said it might be forced to reevaluate the U.S. credit rating sometime within the next decade. Then, in January, Moody’s moved up its timing, saying that recent developments could prompt a downgrade by 2015 or sooner. Those developments include the extension of the Bush tax cuts and other stimulus measures at the end of 2010, which will add about $900 billion to the debt. Moody’s has also expressed concern about gridlock in Washington and the inability of Republicans, Democrats, and Tea Partiers to find some kind of common ground on the issue. “The next two years will provide evidence of the government’s ability to move on this front,” Moody’s warned in January.
[See why low inflation seems high.]
It might sound like a dismal outlook, but Washington would allay fears and cheer investors if Congress and the White House were able to show serious resolve to bring down America’s debt. Most economists feel that would have to involve a combination of tax hikes and spending cuts, much as outlined in the plan released in December by President Obama’s fiscal responsibility commission. The United States also enjoys many advantages that other nations with worse problems don’t. “Most international debt defaults have a very severe political crisis at their heart,” says Cline. “That’s not likely here.” Unless we squander that advantage, too.
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