Can the US repay its public debt?

Over the past decade, much of US borrowing has gone to finance wars in Afghanistan and Iraq [GALLO/GETTY]

According to an August 2011 update issued by the White House, US public debt exceeded $14.6tn in July 2011, and it is increasing by approximately $4.2bn a day. And since the budget deficit for 2011 is projected to be $1.5tn, the public debt is expected to reach $15.4tn by the end of 2011, or some 105 per cent of US GDP.

In light of these facts, can the US government pay its debt in the near future? Can it even service its debt without going deeper into debt? The answers are no: The US has passed the point where it could service its debt without going deeper into debt, let alone repay it.

Can the US do something to ameliorate the debt problem in the short run? Yes. But to do so, the US president and congress have to acknowledge first that the traditional fiscal and monetary tools of economic and financial management are no longer workable. If they continue to follow the largely outdated policies and give priority to political infighting and special interests, the problem will only get worse.

Senator Tom Coburn of Oklahoma, commenting on the political infighting and the severity of the debt problem, wrote, “of my Republican friends I would ask: What good is a Republican Party without a republic? And of my Democratic friends: What good is your commitment to the poor without an economy to sustain your commitments?”

Some simple arithmetic

For the US to gradually reduce its debt as a percentage of its GDP, the annual increase in the size of its GDP has to exceed the size of its budget deficit growth. If the budget deficit, including interest payments, grows faster than GDP, debt as a percentage of GDP will grow as well.

On the other hand, for the US to repay its debt over the long run, it has to have an annual surplus that exceeds the annual interest payments on the debt. According to the Congressional Budget Office (CBO), the last time the US government had a surplus was in 2001. From 2001 to 2009, spending increased by 6.5 per cent of GDP (from 18.2 per cent to 24.7 per cent) while revenues declined by 4.7 per cent of GDP (from 19.5 per cent to 14.8 per cent), causing deficits to increase substantially. For 2011, spending is projected to reach $3.82tn, more than 25 per cent of GDP.

According to the US Department of the Treasury, revenues in 2009 were $2.10tn and expenditures were $3.52tn, yielding a deficit of $1.42tn. In 2010, revenues were $2.16tn and expenditures were $3.45tn, resulting in a $1.3tn deficit. In 2011, the deficit is projected to reach $1.5tn.

US GDP is expected to increase by $100bn in 2011 and by $170bn in 2012, compared with deficits of $1.5tn and $1.2tn, respectively. This means that the increase in GDP represents a fraction of the budget deficits, causing the debt to increase in size as well as in percentage of GDP. At the end of 2010, the debt-to-GDP ratio was 96 per cent. It is expected to reach 105 per cent by the end of 2011, and over 112 per cent at the end of 2012.

According to the CBO, about half of the increase in the debt in the coming ten years will be due to interest payments; the CBO also expects interest rates to reach 4.4 per cent by 2017. Assuming an average interest rate of 3.5 per cent annually and an average economic growth rate of 2.5 per cent annually, and no drastic change in policy, US public debt would reach $28-$30tn by 2021.

As a result, annual interest payments on the debt would reach $1tn, and the debt-to-GDP ratio would rise to 140 per cent. Therefore, under current spending and tax policies, the US is neither able to service its debt without going deeper in debt, nor reduce its size as a percentage of GDP – let alone repay the debt.

Rising debt

Can the US live with a continuously rising debt-to-GDP ratio like Japan? (Japan’s debt is estimated at 226 per cent of its GDP.) I do not believe it can. Socioeconomic conditions and cultural values in the US are different from those in Japan, and therefore what works for Japan is unlikely to work for the US.

Using savings to finance budget deficits has caused Japan’s economy to stagnate [GALLO/GETTY]

Nations usually borrow to close temporary budget deficits, or to invest in projects designed to increase the production capacity of their economies, which causes tax revenues to subsequently rise and eventually close the deficit gap. The US has been borrowing to finance wars and wasteful conspicuous consumption. High savings rates in Japan have enabled the state to borrow from its citizens and recycle their money on their behalf. In contrast, the US government, due to low savings rates, owes about half of its public debt to foreigners who have the capacity to disrupt the US economy by undermining the value of the dollar and causing interest rates to rise substantially.

Despite these differences, using domestic savings to finance budget deficits seems to have caused the Japanese economy to stagnate and lose its dynamism. But since Japan’s population is largely stagnant and its standards of living are high, Japan does not have to create millions of new jobs every year. In contrast, the US has to create about 1.5 million new jobs annually due to population growth – and spend billions of dollars to help the needy due to high unemployment rates that keep rising.

Because the US depends on foreign sources of capital to finance budget deficits, the US cannot have a growing debt-to-GDP ratio without causing substantial damage to the credibility of the US economy and leadership. Experts estimate that when debt reaches 90 per cent of GDP, it causes potential economic growth to decline by one per cent. The US has already passed this threshold.

Debt must be repaid now

What are the options to dealing with the debt problem? The US has few options: To default, which is not considered a serious option; to double the current tax rates, which congress would never do; to go deeper into debt, with no guarantees that lenders will continue to extend new loans to a state that lacks the will to manage its budget and live within its means; or resort to printing money, risking inflation and further weakening the dollar. Therefore, the only way to deal with this problem is to find a new, creative way to repay the entire debt now.

Economists have suggested several debt-to-GDP ratios that are supposedly sustainable. No debt-to-GDP ratio is sustainable or unsustainable without qualifications. Sustainability is a function of three major factors: the annual economic growth rate, the size of the budget deficit, and the expected interest rates. Any state can continue to borrow until markets say: “No more.”

At such a point, however, markets would have lost confidence in the economy and the state’s ability to manage its financial affairs. And markets are on the verge of losing confidence in the US government’s economic, financial and political management, as indicated by S&P’s downgrade of US bonds on August 6, 2011.

Since almost all western states have failed to manage their economies, the question has become not “too big to fail”, but rather “too tall to fall”. However, unless they take drastic measures, all highly-indebted states will eventually fall under the heavy weight of the debt they are carrying on their backs.

Public debt

If the US were to repay its public debt now, the budget deficit would be reduced by some 30 per cent immediately. Such an action would restore US consumer and business confidence, calm the financial markets and give the government an opportunity to grow the economy, while restructuring spending and tax policies. And if the US were to climb back within the coming ten years to where its finances were in 2001, when revenues were 19.5 per cent of GDP and the budget was 18.2 per cent of GDP, it will be in a position to contain its debt and start to gradually reduce its size.  

Adding some $4.2bn daily to the public debt is causing the US financial situation to deteriorate rapidly, and the threat the debt poses to the US economy and the welfare of the American people gets more serious day by day. Poverty, unemployment and despair are on the rise.

The per capita debt is about $47,200 and is increasing by $14 a day, $410 a month and $4,900 a year, with no end in sight.

If the US continues to finance spending by borrowing and printing money, it would not take the financial markets long to lose confidence in the US economy and the US dollar. If this were to happen, the international pool of easy money would dry up quickly, and interest rates would rise substantially, forcing the US government to rely solely on borrowing from the American people, printing money faster and raising taxes. This is a good recipe for a prolonged state of stagflation, if not depression.

Dr Mohamed Rabie is an author and a professor of international political economy. He has studied, lived and taught in four continents, and lectured at more than 60 universities and research institutes worldwide. He has published 26 books and more than 1,000 papers and articles. Dr Rabie‘s commitment to peace, freedom, social justice and human rights is reflected in his interests, writings and activities.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial policy.