CBO Warns Obama: Exploding US Debt a Huge Risk

Thursday, 29 Jul 2010 11:13 AM

By Dan Weil

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The mushrooming U.S. government debt burden may cause a new financial crisis by spurring a sharp rise in interest rates, warns Doug Elmendorf, director of the Congressional Budget Office (CBO).

Countries such as Greece already have seen such crises, as their debt buildups sent interest rates soaring and drove away international bond investors.

The CBO projects that U.S. federal government debt will reach 62 percent of GDP by Sept. 30, up from 36 percent just three years earlier. Only once before has that figure surpassed 50 percent, during and just after World War II.

The debt, of course, is created by massive budget deficits, with the White House projecting a gap of $1.47 trillion this year.

Elmendorf sees two possible outcomes for our current predicament – one mild, one harsh.

As for the mild alternative, “It is possible that interest rates might rise gradually as investors’ confidence in the U.S. government’s finances declined, giving legislators sufficient time to make policy choices that could avert a crisis,” he wrote in a blog on CBO’s website.

“It is also possible, however, that investors would lose confidence abruptly, and interest rates on government debt would rise sharply, as evidenced by the experiences of other countries.”

Current government policies aren’t encouraging, Elmendorf notes.

Spending on Social Security and Medicare are set to ratchet higher as the population ages.

“Unless policymakers restrain the growth of spending, increase revenues significantly as a share of GDP, or adopt some combination of those two approaches, growing budget deficits will cause debt to rise to unsupportable levels,” he wrote.

Rising deficits right after a recession are helpful in bringing the economy back to life.

“But a high level of federal debt, combined with an unfavorable long-term budget outlook, would also increase the probability of a sudden fiscal crisis,” Elmendorf writes.

Investors worry that the government would either demand easier terms for its existing debt or boost money supply to finance the debt burden, risking an inflation outbreak.

To be sure, it’s impossible to predict whether a crisis will indeed hit, and if so, when, Elmendorf says.

“There is no identifiable ‘tipping point’ of debt relative to the nation’s output that would indicate that such a crisis is likely or imminent,” he wrote.

But obviously the steep climb of U.S. debt raises the risk.

Experts outside the government are worried about the deficit and debt trends also.

Pimco’s star chief investment officer Bill Gross put it graphically in a commentary on the firm’s website.

“Current deficit spending that seeks to maintain an artificially high percentage of consumer spending can be compared to flushing money down an economic toilet,” he wrote.

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