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Charging the Future

Striking a Balance

A golden line of credit

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With soaring deficits burdening state coffers in the wake of the global financial crisis, current US fiscal policy illustrates the delicate balance governments must find between stimulus spending and fiscal accountability.

By Peter Buxbaum

Do government operations and the accumulation of debt go hand in hand?

David Hume, the 18th century Scottish philosopher, thought so. Two-hundred fifty years ago he predicted that "the practice of contracting debt will almost infallibly be abused in every government." "It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London," he mused, "than to empower a statesman to draw bills upon posterity."

Governments, like companies or households, can shoulder limited levels of debt with impunity. But the discussion around the world has now turned to whether governments' debt loads are so heavy that they could lead to economic collapse.

In the US, the federal government's tax collections are lower thanks to the recession, while its spending has spiked, with hundreds of billions of dollars going to massive stimulus and bailout programs. These factors, combined with waging two wars without raising the revenues to pay for them, have some worrying that a perfect debt storm is brewing which could, if not reversed, severely compromise the US economy and government in coming years.

The US currently owes its creditors over $12 trillion and rising. The ratio of debt to GDP has more than doubled the last two years, from 40.3 percent in September 2008 to nearly 86 percent today.

"If we fail to act soon," said Senator Kent Conrad, a Democrat of North Dakota, at a recent US Senate budget committee hearing, "federal debt will overwhelm the nation’s budget and economy."

Under current trend lines, the US national debt could rise to several times its annual GDP before too long.

David Walker, a former US comptroller who has long advocated controlling unfunded government obligations, recently testified before the US Congress that long-term entitlement obligations has created a "federal financial hole [of] about $10 trillion more than the current estimated net worth of all Americans, and the gap has been growing."

Wavering confidence

One likely consequence of the continued accumulation of government debt is a scenario in which investors perceive increased risk to holding US Treasury securities and start demanding higher interest rates. That would make paying interest on the cumulative debt that much more difficult.

In the absence of tax hikes and/or spending cuts, the government would have little alternative but to borrow still more money. Or, investors could cut back on buying US Treasury notes, forcing punitive tax increases and draconian spending reductions.

"For now, investors are buying" despite low rates of return, said Richard Berner, chief US economist at Morgan Stanley.

But Berner is concerned about what will happen as the debt-to-GDP ratio continues to creep upward. "History shows that such a jump in debt may boost debt service at the expense of other needs and with not much to show for it," he said.

At what point do capital markets lose confidence in the future viability of US securities?

"There is no magic, bright-line numerical cutoff for the debt-to-GDP ratio that signals a safe harbor below or threat above," said Douglas Holtz-Eakin, an economist, consultant and former advisor to Senator John McCain. "Instead, the fundamental evaluation is whether global capital markets believe in the fundamental rough balance of future budgetary policies."

Averting disaster

Economists from across the spectrum agree that stimulus spending was, and perhaps will continue to be, necessary to keep the US economy afloat, thus incurring larger deficits and debt. The question then becomes, what kind of spending programs will do the least harm to a government's long-term debt picture?

"Any necessary sharp, near-term rise in federal debt should be paired with a strategy to address the underlying forces driving up federal spending," said Holtz-Eakin.

For example, a "stimulus effort should avoid new policies that create new spending programs," he said. "These types of programs would exacerbate the underlying spending growth that is feeding unsustainable debt projections."

Observers concerned about deficits and debt are therefore expressing concern over the health insurance reform legislation now pending before the US Congress. The Senate and the House of Representatives passed different versions of such a program late in 2009. The measures must be reconciled into a single measure and passed by the two chambers before it can be signed into law by President Barrack Obama.

Although proponents of health insurance reform claim that it is 'deficit neutral' and that it will reduce the government's health care costs over the long term, others are skeptical.

"There is an air of absurdity to what is mistakenly called 'health-care reform,'" wrote Robert Samuelson in the Washington Post. "Everyone knows that the US faces massive governmental budget deficits as far as calculators can project, driven heavily by an aging population and uncontrolled health costs. As we recover slowly from a devastating recession, it's widely agreed that [...] a prudent society would embark on long-term policies to control health costs, reduce government spending and curb massive future deficits.

"So what do they [the president and Congress] do? Just the opposite," Samuelson argued. "Their far-reaching overhaul of the health-care system [...] would almost certainly make matters worse. It would create new, open-ended medical entitlements that threaten higher deficits and would do little to suppress surging health costs."

In some countries, investor pressure is already forcing governments to slash spending in order to control debt. In December, the government of Ireland trimmed $4 billion in spending that cut government salaries as well as payments to the unemployed and the disabled.

Greece's new Socialist government, which came to power in October promising to protect state salaries and public spending, unveiled a budget late in the year that hiked taxes, froze public sector hiring, and cut social security and government operating expenditures by 10 percent. This, after three international ratings agencies downgraded Greek bond ratings.

Might not the US have to follow suit before too long?


Peter Buxbaum is a Washington-based independent journalist, who has been writing about defense, security and technology for 15 years. His work has appeared in publications such as Fortune, Forbes, Chief Executive, Information Week, Defense Technology International, Homeland Security and Computerworld. His website iswww.buxbaum1.com.

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