Thursday, October 9, 2008

Is There Anything To Worry Over The US Ballooning Debt?

The national debt clock in Times Square is unable to sustain additional zero

What is national debt?

National debt is the amount of money that US government owed to holders of its debt instruments such as treasury bills (maturity is 1 year or less), treasury notes (maturity period between 2 years to 10 years), treasury bonds (longest, around 30 years) etc. The creditors can be Americans or foreigners. Few days ago, the US government announced that this debt has surpassed US $ 10 trillion (up from $ 9.5 trillion) & is currently standing at about 70% of its GDP. Not even can the national debt clock contains the additional zero

Why national debt increases?

(1) Financial bailout. This is the main argument. Bulk of the money is wasted to bail out those inefficient banks which ran into the sub prime mortgage crisis which stemmed from reckless lending. Also it is argued that US government is buying over worthless assets or some called it toxic debts. These monies is better off if spend onto education, infrastructure & healthcare sector which have positive long term supply side effects

(2) Increasing number of elderly people. Over the years, life expectancy had increased. Along the way, with growing number of old people, there is an intense pressure onto the US government to continuously pump money into the healthcare sector

(3) Tax cuts. There were several tax cut measures earlier on to revitalise business & to encourage people to spend. Somehow this fall in tax revenue is not matched by the massive increase in government spending. As such it ran into budget deficit

(4) Military spending. This has got to do with the financing of military operations in Iraq

Is there anything to worry about the ballooning national debt?


(1) Higher tax. If the debt further increase, it means the US government is liable to pay higher interest repayments. As such income tax & corporation tax may increase gradually over the years just to finance the debt. This is certainly a bad news for consumers & firms

(2) Crowding out effect. Increase government borrowing from the private sector will cause a competing demand for money. As such interest rates will be bid up & this will crowd out households’ spending & firms’ investment. Another way to look at this is, if private firms buy the bond they will in return have lesser funds for investment

(3) Inflationary pressure. If the debt is growing out of hand, very likely US government will struggle to find sufficient number of buyers of the bond. To fill the gap, they may be tempted to start printing money & this will cause inflation as money supply increase. This also explains the events of hyperinflation in Germany in 1922-23 & the case in Zimbabwe

(4) Borrowing is not to finance economy. If the US government borrows to finance investment onto infrastructure such as new & more efficient roads, communication etc, then we may witness a long term US economic growth due to the supply side. That time, the government may be able to collect more tax revenue to reduce its debt burden. In the present state, the monies borrowed are not meant for productive use e.g. bailing out failing banks, paying pensions etc. This will not contribute to economic growth

(5) Not inclusive of other debts. It is argued that the actual national debt is much larger if we were to include social security & other form of social insurance which the government is obliged to pay. Adding this together, the figure of debt will amount up to US$ 59.1 trillion (wikipedia) & that is about 400 % of its GDP

(1) Worse debt in the past. During the World War II, US’ national debt is standing at a much frightening figure of 150% of GDP (same like UK). This is an example, how a country can borrow during the period of crisis & gradually paying it back over the time.

(2) Economic growth. If the US government plan is successful in lifting the fear among consumers, very soon the US economy will rebound with falling unemployment, better performance of the Dow Jones, business expansion, increasing retail sales etc. That time, government can raise taxes to part finance the debt & the rest to reinvest onto the economy particularly on infrastructure spending. Technically speaking, if the increase in real GDP is faster than accumulation of the debt it should be fine.

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