No one argues that the staggering deficits run up by the American government in a bid to rescue the economy are desirable, healthy or even sustainable — not if the national debt continues to swell at its current pace. But considerable debate centers on when and how vigorously to start easing off Washington’s borrowing habit, with substantial risks at both extremes.
Pull back on government spending now, the argument runs, and condemn an already hobbled American economy to years of mass joblessness and anguish. Indeed, some economists are already arguing that with unemployment near double digits, the government must consider giving another dose of stimulus spending now, despite the fact that this will add to the deficit.
Keep spending with abandon, goes the counterargument, and invite the possibility of a debt crisis with spiking interest rates, crippling inflation and a plunging dollar.
Those arguing for tighter federal spending to contain the budget deficit contend the nation has already borrowed so much money that the people who have lent it may get spooked and abruptly refuse to supply more.
China’s central bank and other foreign creditors might curb their purchases of American government savings bonds, which finance so much national spending. That would force the Treasury to pay higher interest rates to attract other buyers of its debt, lifting interest rates throughout the American economy.
And that would increase the costs of borrowing for companies and ordinary families alike in the midst of economic weakness, like a wet blanket thrown on an already weak fire.
“We are not an island,” said Martin N. Baily, chairman of the Council of Economic Advisers under President Bill Clinton and now a fellow at the Brookings Institution. “We are part of the global economy, and there are concerns out there among those who have been buying our debts that we owe too much.”
But others argue that now is precisely the wrong time to worry about the deficit. Yes, the risks of growing indebtedness are real and unpalatable, but there are no appetizing options on the menu — not at a time of 9.5 percent unemployment. In this view, debt must take a back seat to the imperative to spend money and stimulate the economy to create jobs.
In this view, pulling back now in the interest of limiting the deficit would be akin to withholding pharmaceuticals from a patient stricken with a potentially fatal disease because the treatment might itself leave long-term damage.
The deficit has grown in part because of the $787 billion spending package championed by the Obama administration to aid states, generate jobs and increase benefits for the jobless. But these expenditures landed atop huge deficits run up by the Bush administration, which had cut taxes and prosecuted an expensive war in Iraq.
If policy now tilts too far toward deficit cutting, some argue, that would treat job creation as an option the nation somehow cannot afford, in contrast to “must haves” like tax cuts for wealthy Americans and unpopular foreign military entanglements.
“We certainly have to tolerate the deficits we have now,” said Lawrence Mishel, president of the labor-oriented Economic Policy Institute. “Any effort to cut them now would be foolhardy and cruel. This concern about the deficit in effect says to the American people, ‘tough luck.’ ”
On one point alone, no debate is required: The United States already owes staggering sums of money and will soon owe more.
The Congressional Budget Office projects federal spending will exceed revenues by $1.7 trillion this year, or about 12 percent of the nation’s annual economic output — the largest deficit since World War II.
“The budget outlook at every horizon is troubling,” declared Alan J. Auerbach, a finance expert at the University of California, Berkeley, and William G. Gale, an economist at the Brookings Institution, in a recent paper. “The fiscal year 2009 budget is enormous; the 10-year projection is clearly unsustainable; and the long-term outlook is dire and increasingly urgent.”
The budget office estimates that federal debt will reach $12 trillion by this fall and exceed $13 trillion by September 2010. Merely paying the interest on this year’s debt will cost taxpayers $565 billion, or 4 percent of the nation’s annual economic output.
“The magnitudes are very worrisome,” said John B. Taylor, a former member of the Council of Economic Advisers under the elder President Bush and now a professor at Stanford.
Like his fellow deficit hawks, Mr. Taylor is particularly concerned about inflation. Absent sustained and robust economic growth, the only way for the United States to pay down its debt is to cut spending or raise taxes — both politically difficult. That may tempt the government to take a seemingly easier course: print money to pay the bills.
Creating money out of thin air tends to increase prices, raising the possibility of the return to the sort of inflation that crippled the economy in the 1970s.
“I’m absolutely worried about inflation,” Mr. Taylor said.
Many economists dismiss inflation concerns in the short term. With so much of the world ensnared by the economic downturn, demand for goods and services is weak, which tends to push down prices. Amid high unemployment, workers are in no position to demand wage increases.
But the longer term is laced with uncertainty and potential policy mistakes. The bigger the deficit, the bigger the potential consequences of any mistakes.
Even the rosiest projections envision the national debt expanding considerably over the coming decade. The budget office forecasts that the cumulative federal budget deficit for the years 2010 through 2019 will run to $4.4 trillion. In their paper, Mr. Auerbach and Mr. Gale dismiss those numbers as overly optimistic, estimating the 10-year deficit at $10.1 trillion.
Yet even as they sound the alarm, they point to history in cautioning against trying to shrink the deficit too quickly.
In Japan in the late 1990s, the government prolonged a decade-plus downturn by increasing taxes before the economy recovered, they say. In the mid-1930s, the Roosevelt administration suffocated growth spurred by aggressive government spending by imposing austere tax and spending policies too quickly, lengthening the Great Depression.
Adding risk to the contemporary equation, a host of unknowns seems likely to increase federal spending. The Obama administration is seeking to expand access to health care while insisting that any new program be paid for, but estimates of costs diverge widely.
Taxpayers have allocated $700 billion to aid troubled financial institutions and automakers, with the expectation that some will be recouped through selling assets and stakes in bailed-out companies. But how much will be returned exactly is a major unknown.
For now, the Treasury continues to find takers for government savings bonds at low interest rates. But somewhere between here and infinity lies a point at which American debt reaches unsustainable proportions, at which investors will balk at continuing to finance the American expenditures absent a higher return on their investments. Then, everything could change quickly, with interest rates soaring and the value of the dollar plummeting, as foreign investors lose faith in its fundamental value.
“We’re running this $10 trillion gamble that interest rates aren’t going to rise,” said Kenneth S. Rogoff, a former chief economist at the International Monetary Fund and now a professor at Harvard. “If they do, we could end up in a very difficult situation.”
During the last decade, the United States has come to depend on borrowing at exceedingly low rates courtesy of a global savings glut: China and other fast-growing economies harvested their winnings from booming exports and invested them in American bonds.
Coming years are likely to look different, economists say. China and India are increasingly focused on investing their money at home to spur domestic growth. Russia is in turmoil. The developed economies of Western Europe, struggling as well, are more likely to invest in Eastern Europe when economic growth resumes.
Meanwhile, foreign creditors behold the spectacle of California, stumbling to balance its books, and see a potential microcosm of American political weakness: no one wants to cut favored programs, and no one has the guts to raise taxes.
“Suddenly global investors look out and say ‘Wait a minute, are Americans really willing to tax themselves to pay us back?’ ” Mr. Rogoff said. “We’re at risk. The history of financial crises is that you’re rolling along, and then there’s a loss of confidence.”
Yet even as Mr. Rogoff argues for “hard-headed decisions about spending” to trim the deficit, he assumes the economy may need another jolt of stimulus spending this year if weakness endures.
In a time when none of the options are good and nothing offers a clear fix, the deficit weighs as one huge concern among many.
“We should be worried,” said Brad W. Setser, an economist at the Council on Foreign Relations. “But not so worried that we’re unwilling to take actions that stimulate the economy.”