U.S. Debt: Not Bound by our Borders

Dec 17, 2009

With U.S. debt held by the public on track to exceed 100% of the economy in a little over a decade, policymakers must come together now and implement a plan for getting our fiscal house in order. Otherwise, our economic future, as well as that of the rest of the world, is at risk. The Peterson-Pew Commission on Budget Reform recently released a report that examines the consequences of the large government debt and suggested a plan for lowering that debt to 60 percent of GDP (an international standard). The report received widespread attention, including from The Economist, Wall Street Journal, and Capital Gains and Games.

Our debt has implications far beyond our borders. But we are not the first to deal with overwhelming debt and the United States can learn some lessons from other countries.

The bad news first:

A large and growing portion of our debt is held by foreign investors (see page 12 of the report). Without the reassurance that comes from having a plan to bring U.S. debt down to a sustainable level, those investors may begin demanding higher returns on their investments (thus, pushing interest rates up), or reduce lending to us altogether. This would hurt our ability to react to economic crises in the future, and to continue to pursue economic growth.

We are already starting to see some nervousness among our international creditors. China, our largest foreign creditor, has recently voiced concern over whether our debt, and its expected growth, is sustainable. And while U.S. Treasury debt instruments continue to be a safe haven for many investors, there is no telling when a fiscal crisis might trigger a change in that scenario. Some fear the United States may not continue to be the world’s reserve currency. The IMF and the UN have already begun to investigate a worldwide reserve currency as a potential alternative to the dollar.

Now the good news:

The United States is not the first country to face an unsustainable debt burden, and other countries have been successful in lowering their debt and improving their economic prospects (see pages 16 and 17 of the report and this paper on other fiscal success stories). While not perfect comparisons, those examples show that bringing a country’s debt to a sustainable level is possible.  After a series of missteps, Canada successfully brought its debt level down and enjoyed a decade of budget surpluses.

However, we would be wise to learn from the mistakes of most other countries who undertook debt reduction: don’t wait too long. In many, if not most, cases, debt reduction came only with difficult and rapid policy changes after an economic crisis struck, precipitated by high debt and persistent deficits. Economies and people suffer greatly when their government fails to act until it is too late. Without concrete action soon, we might face an economic crisis sooner than we think, and our nation might lose its global clout.