A Stagerring Federal Deficit That Many Expect to grow - NYTimes.com

By PETER S. GOODMAN
Published: July 7, 2009
The New York Times

Excerpt:
...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, ...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.”

...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...

...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,... 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.

But the longer term is laced with uncertainty and potential policy mistakes. The bigger the deficit, the bigger the potential consequences of any mistakes...

“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...

“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.”

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