Tuesday, December 30, 2008
How much debt can the U.S. afford?
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Zachary Courser
Courser is a visiting assistant professor of politics in the Williams School of Commerce, Economics and Politics at Washington and Lee University in Lexington.
In his 1790 message to Congress on the public debt, Alexander Hamilton, the first secretary of the Treasury, solemnly referred to the nation's financial obligations as "the price of liberty." The finances of the newly established nation were in chaos, and Hamilton understood that establishing the credit-worthiness of the new nation was as much an economic necessity as a moral one. "Not worth a Continental," a popular phrase of the day referring to the money issued by the Continental Congress, was a baleful reminder of how the nation had failed to meet its obligations.
Hamilton reassured America's debt holders that they would be repaid in full while assuming the war debts incurred by the states and backing the promises with the revenues generated by federal tariffs. Within a short time Hamilton firmly established America's bedrock reliability in repaying its debts. And the benefits to America's prestige and economic success, not to mention its ability to fund emergencies, have ever since been tied in no small way to its outstanding credit.
Even during the Great Depression, when commercial credit was scarce and the economy was at a virtual standstill, the federal government funded the New Deal's recovery programs by borrowing cheaply. In those direst of economic circumstances, America's credit worthiness allowed Congress and President Franklin Roosevelt to pass budget deficits that averaged more than 70 percent of government revenues. And even with continuing deficits, the national debt averaged only 3.7 percent of GDP during the 1930s.
Today, another emergency forces the United States to draw upon its credit to protect the economy from a possible second Great Depression. This time, however, America's balance sheet is more precarious than in the 1930s. For the last 10 years, debt as a percentage of GDP has averaged more than 60 percent, and this year's budget deficit is already well on its way to $1 trillion.
The actions of the Treasury Department and Congress to bail out the financial sector may have been necessary despite its shocking, $700 billion price tag. But it raises this question: How much debt can the United States credibly incur? The question is even more pressing if one considers the potential losses the federal government could incur after taking financial responsibility for Freddie Mac and Fannie Mae, which own or guarantee a combined $6 trillion of U.S. mortgage debt. And yet Congress's current proposal for dealing with the economic downturn, backed by Federal Reserve Chairman Ben Bernanke, is to spend even more on another stimulus package.
Putting aside the question of whether such a stimulus package would actually help the economy, is it wise to further mortgage the reputation of the United States by attempting to borrow its way out of economic crisis?
Looking at Congress's and the incoming administration's ideas for recovery, it seems as though every policy maker believes the United States possesses a blank check ensuring unlimited credit at low cost. Some economists and policy makers insist the economic might of the United States could reliably allow the government to continue shouldering an ever-increasing burden of national debt. But is it wise to test how far the country can go in borrowing its way out of trouble?
Hamilton acknowledged the principle that, at times, "public debts are public benefits," but warned the principle was an invitation to "prodigality, and liable to dangerous abuse." He thought the "true secret for rendering public credit immortal" was to make certain that "the creation of debt should always be accompanied with the means of extinguishment."
The United States currently relies on countries like China and Japan to buy its debt to fund the deficits and financial obligations it incurs. In doing so, the federal government is making itself a hostage to fortune by expecting that foreign investors will continue to purchase its debt, regardless of how prodigal its spending becomes.
Clearly the economic fate of the world is closely bound to the future health of America's economy, and many countries would likely help prevent anything as catastrophic and unimaginable as a credit default. But does the United States want to become the next institution that is considered "too big to fail"? And if the federal government should falter in its debt obligations, what of the increased costs of maintaining its debt, already swallowing up to 13 percent of the budget?
The mortgage crisis has reminded us that perception is value in financial markets. If the perception grows that the United States is nearing its limit, the damage done to its credit could be the costliest loss of all.
