Whats the worst that could happen with the US national debt?

[Serafina]

Ok, there are a lot of complains, and much doomsaying about the massive debt that the Us-goverment has, especially with foreign nations.
But what IS the (reasonable) worst case scenario? What could happen, and how?

My understandings of economics is solid to know that this burdens the budget with payments and that an overly large debt can invaldiate a currency. But thats a long-term process -are there any immediate threaths from this?
Of course, this question also applies to other nations, but i want to focus mostly in the USA.

(I figured this is a political question, hence N&P - move it to another forum if it's he wrong place.)
Regards
Fina

[Prannon]

The Economist has a fair article on the topic. The basic point of the article is that the US will face a debt crisis that will not be sudden or particularly devastating, but will be long term and felt for many, many years. Sort of like the frog slowly being boiled to death analogy.

Here's the full text of the article:

AS AMERICA’S financial crisis recedes, the rumblings of its next crisis can be heard. The federal government has wrapped its guarantees around banks and the housing market. It has borrowed hundreds of billions of dollars to stimulate the enfeebled economy, while tax revenues crumble. And in the years to come the cost of retirees’ benefits will explode. “There is every reason to worry that the banking crisis has simply morphed into a long-term government-debt crisis,” says Kenneth Rogoff of Harvard University.

But what kind would it be: acute or chronic? If it were an emerging market, America would probably have hit trouble already: foreigners would have recoiled from financing its gaping budget deficits; default or a bail-out would have followed. The past two years have shown that rich countries are not immune to acute crises. Iceland’s case has been the most severe: the IMF had to save the country from collapse. Others have displayed milder symptoms: credit markets have discounted meaningful odds that Greece, Ireland or Italy would default. But although an acute crisis cannot be ruled out, America’s is far more likely to be chronic. Its expansion is likely to be sluggish and deflationary, which make it economically and politically hard to reduce debt.

Of course, America could still give investors a scare. Within two months the Treasury will probably have reached the statutory limit on the amount of debt it can issue. In a peculiarly American ritual, Congress often grandstands before agreeing to raise it. In 1996 its Republican leaders unsettled markets by pooh-poohing the consequences of default before eventually granting Bill Clinton’s request.

The Treasury’s ravenous borrowing needs also leave lots of opportunities for something to go wrong. In the past two years the portion of its debt maturing in less than a year has jumped from 30% to over 40%, the most since the early 1980s (see chart 1). In the fiscal year that ended on September 30th the Treasury held an auction on average more than once a day to finance nearly $7 trillion of new and maturing debt. A failure to raise as much money at an auction as planned—as occurred in Britain earlier this year—could send a shudder through global financial markets. “Other countries can afford a failed auction; we can’t,” says Lou Crandall, chief economist at Wrightson ICAP, a financial-research firm. “What do you do when there is a confidence shock to your flight-to-safety asset?”

But it is difficult to identify any such concerns today. If anything, the underlying demand for Treasury bonds is rising. Mr Crandall notes that in the past year the share of Treasury debt bought at auctions by big investors and foreign central banks (as opposed to dealers) has roughly doubled to around 60%. Yields on ten-year Treasuries, at 3.3%, are lower than they were in August 2008, before bail-outs and recession sent projected deficits into the stratosphere.

It may be that other, temporary forces, such as the lack of private borrowing or the Fed’s easy monetary policy, are offsetting any worries about deficits. Yet Tom Gallagher, an analyst at ISI Group, a broker-dealer, estimates that investors’ expectations of yields in five years’ time, when such temporary factors will have faded, are no higher than they were last summer. The reason, he says, is not that bond investors do not care about deficits, but that they assume—perhaps wrongly—that politicians simply will not allow those deficits to materialise.

America may be the world’s strongest borrower, thanks to its size, wealth, legal and political stability, and two centuries of timely debt repayment (the one exception being its abrogation in 1933 of a promise to repay some bondholders in gold). Such demonstrated willingness to pay means a lot to lenders, because they cannot push countries into bankruptcy court.

America also borrows in the currency other countries most want to hold in their own foreign-exchange reserves. In May Standard & Poor’s said Britain could lose its AAA rating. America has been spared the same fate in part, S&P says, because of the “unique external flexibility” granted by the dollar’s reserve currency status.

Recently China and other countries have questioned that status, advocating greater use of other currencies or a currency basket like the IMF’s Special Drawing Right (SDR). Yet the dollar’s share of global foreign-exchange reserves has remained high. It fell to 63% in mid-2009 from 72% in 2001 because of the decline in its value, not reduced demand. The share was 59% in 1995. The data show central banks buy more dollars when it falls and less when it rises, says Stephen Jen of BlueGold Capital, a hedge fund. The view of Kazakhstan’s central-bank governor, Grigory Marchenko, is typical. His country will eventually reduce the dollar’s share of its reserves, he said last month, but not for a long time: “There’s no alternative yet.”

SDRs’ potential is limited by the fact that only governments use them. The euro is still young and the euro zone’s borders are not yet fixed. China’s economy may one day rival America’s. But Dino Kos, a former chief of markets at the Federal Reserve Bank of New York who now works for Portales Partners, a research firm, notes that the yuan does not meet one of the most basic requirements of a reserve currency: other countries cannot use it to intervene in foreign-exchange markets because it is not freely convertible. Moreover, central banks loathe uncertainty; the arrest of four Rio Tinto employees this year on charges of stealing state secrets (downgraded to obtaining commercial secrets) shows that China’s legal system remains capricious.

Eventually, the dollar’s dominance will fade; but as with sterling in the last century, this will take decades. Of course, American policies could hurry it up, in particular by trying to reduce the debt burden through inflation. In March the Federal Reserve began buying $300 billion in Treasury bonds to push down long-term interest rates. Such purchases amount to printing money, and aroused fears that the Fed was subordinating inflation-control to helping the government finance its deficits. “I must have been asked about that a hundred times in China,” Richard Fisher, president of the Federal Reserve Bank of Dallas, told the Wall Street Journal in May.

But inflation is harder to create than you think. It would require the economy to grow so rapidly that unemployment plummeted and businesses returned to full capacity. Even the most optimistic forecasts say that is years away. Inflation could rise more quickly if the public came to expect higher inflation. But Donald Kohn, vice-chairman of the Fed, recently predicted that both inflation and inflation expectations were more likely to drop than to rise.
Trouble in slow motion

In short, the likeliest triggers of an acute crisis—a lenders’ strike, a crash in the dollar or inflation—seem remote. Not so the damage of a chronic, slow-motion crisis. Publicly held debt, just 37% of GDP two years ago, has already jumped to 56%. How much further it rises depends crucially on how fast the economy grows: higher growth leads to narrower deficits and a larger GDP to support the debt. The White House sees deficits stuck at around 4% of GDP and the debt ratio reaching 77% by 2019. The IMF, which forecasts lower growth, sees the deficit rising to around 7% of GDP and the debt ratio to 100%. The Congressional Budget Office (CBO) is in between (see chart 2).

Debts of that magnitude elevate interest rates, crowd out private investment and damp growth. In 2004 William Gale of the Brookings Institution and Peter Orszag, now Barack Obama’s budget director, estimated that an increase of 1% of GDP in future deficits would raise long-term interest rates by 0.4-0.7 percentage points. They reckoned that continuing deficits of 3.5% of GDP would reduce national income by 1-2%. Rising debts also force the government to divert tax revenue from public services to interest payments. The CBO estimates that by 2019 interest on the national debt will consume 3.8% of GDP, more than twice its share earlier this decade.

Bigger deficits raise interest rates not just by competing for savings, but by raising doubts about America’s ability to repay the money. Moody’s Investors Service notes that, including what states owe, America’s government debt will hit 100% of GDP in 2010, higher than other AAA-rated nations (see chart 3). “If it looks like, after the crisis is over, the trajectory of the debt is going to be continuously upward, I’d say the rating could be in jeopardy,” says Steven Hess, an analyst at Moody’s. Canada lost its AAA credit rating in the early 1990s as its combined federal and provincial debt ratio neared 100%. (It won it back in 2002.) Japan was marked down in 1998 when its ratio hit 115%. Ireland lost its AAA grade this year when the banking crisis exposed the government to huge risk.

Mr Hess remarks that banking crises often trigger downgrades, as in Ireland earlier this year and Sweden in the early 1990s, because the government ends up backing a lot of private-sector liabilities. America has implicitly backed the biggest banks and much of the residential-mortgage market. The extra exposure, Mr Hess notes, is far smaller than Ireland’s. Still, if growth proves weak, the public will be on the hook for more bad private debts.

A rating downgrade would not be cataclysmic; AA-rated countries borrow without problems. But interest rates would rise for the Treasury as well as anyone else who borrows in dollars, including corporations and state governments. Higher interest payments would mean further pressure on the deficit and debt.

Stabilising debt as a share of GDP requires some combination of faster economic growth, higher taxes, or lower spending. It can be done. The ratio topped 100% during the second world war. It later fell rapidly as defence spending shrank, the economy bounded forward and policymakers made some difficult choices: Harry Truman paid for the Korean war with higher taxes. In recent decades several heavily indebted rich countries have clawed their way back to health without resort to default or inflation, notably Canada, Denmark and Sweden.

These episodes provide little comfort to America now. Its defence budget is too small, as a proportion of GDP, to make a meaningful contribution to deficit reduction. Both Canada and Sweden started with large public sectors and shrank them; Mr Rogoff notes that America’s public sector is expanding. More important, devalued currencies and strong exports boosted growth while they wrestled down their deficits. In contrast, American exports are much smaller relative to GDP and the rest of the world remains sickly. Falling interest rates provided a tailwind to deficit reduction in all countries through the 1980s and 1990s as inflation phobias accumulated over prior decades seeped away. America is more likely to experience the opposite since its interest rates are already so low.

Japan’s example may be more relevant. Beginning in the early 1990s, a prolonged banking crisis, sluggish growth, deflation and numerous stimulus plans drove its debt ratio up dramatically; it is still rising. Its interest rates remain low, largely because Japan borrows almost entirely from its own citizens whereas half of America’s debt is owed to foreigners. Japan tried to corral its debt by raising taxes in 1997; it promptly snuffed out a recovery.

Japan’s experience illustrates the excruciating dilemma facing American policymakers. The White House acknowledges the deficits it projects are too high. But slashing spending or raising taxes too soon could snuff out recovery and leave America with even bigger deficits. Asked on October 15th when the administration would tackle the deficit, Tim Geithner, the treasury secretary, said: “First, growth.”

[Edi]

Thread title fixed. The correct term for when you owe someone money is "debt", while "dept" is often short for "department" in English.

The p and b keys on a qwerty keyboard are not close enough together for anyone getting the benefit of the doubt for an accidental mistype.

[Duckie]

Thread title fixed. The correct term for when you owe someone money is "debt", while "dept" is often short for "department" in English.

The p and b keys on a qwerty keyboard are not close enough together for anyone getting the benefit of the doubt for an accidental mistype.

Actually, the two are of similar articulation point and manner*. Their only difference is that they are voiced and unvoiced. Linguistically, this is the easiest phonetic mistake to make short of perhaps m->n assimilation in English for a generic foreign speaker.

For a german like Serafina, 'bt' cannot occur in her native tongue, and she pronounces it 'pt' for a similar reason traditional (pre-loanword) Finnish does not have b or g. It's entirely reasonable they would make such a typo if they are writing what they are hearing in their own head, similar to people such as myself writing 'imput' rather than 'input' by assimilation.

*Articulation point is where your tongue is, like where your fingers are on a guitar. Manner is what your breath does, like what note you pluck. B is a different point that D or G (bilabial compared to alveolar/dental and velar respectively). V is a different Manner than B (fricative vs plosive). Voicing is what separates p/b, t/d, k/g, f/v, etc. which have the same articulation point and articulatory manner but differ by a binary 'vocal cord vibration? yes/no.' distinction.

[Terralthra]

Their articulation being similar should be largely irrelevant, since the b is silent in "debt." Back in VL/OL, it was a two-syllable word "debit," but that has been lost since AF.

[Surlethe]

Back on topic.

[J]

If anything, the underlying demand for Treasury bonds is rising. Mr Crandall notes that in the past year the share of Treasury debt bought at auctions by big investors and foreign central banks (as opposed to dealers) has roughly doubled to around 60%.

This is technically true, however it's because of a change in the way direct & indirect bids are counted which was put into effect earlier this year. In the past, if a buyer placed a bid for Treasuries through one of the primary dealers it was counted as a direct bid, under current rules it's now counted as an indirect bid. In addition, the Fed is carrying out back door purchases of its recently auctioned Treasuries where primary dealers & other parties can flip their newly bought bills for a profit. One would be silly not to buy Treasuries if one can resell them to the Fed for a gain within a week.

Yields on ten-year Treasuries, at 3.3%, are lower than they were in August 2008, before bail-outs and recession sent projected deficits into the stratosphere.

Sure, but only because the Fed is bidding them down through outright purchases at the auctions and through the hidden buyback mechanism detailed above. When the Fed runs out of the means to carry out the above and existing bondholders have an "uh-oh!" moment, the rates will shoot upwards rather dramatically.

I'll cover the rest later today when I have a bit more time.

[J]

Ok, there are a lot of complains, and much doomsaying about the massive debt that the Us-goverment has, especially with foreign nations.
But what IS the (reasonable) worst case scenario? What could happen, and how?

My understandings of economics is solid to know that this burdens the budget with payments and that an overly large debt can invaldiate a currency. But thats a long-term process -are there any immediate threaths from this?
Of course, this question also applies to other nations, but i want to focus mostly in the USA.

A reasonable worst case scenario is one or more failed US Treasury auctions followed by what's known as a bond market dislocation. In a dislocation the potential buyers of US debts demand much higher interest payments from the US, the interest rate on the benchmark 10 year US Treasury bond goes from about 3.5% where it is now to 10% or more almost overnight and continues rising. In fairly short order it becomes a lot more expensive for the US to service & support its debts and the money required to do so will be a large drain on the budget & economy. Shorter & longer term interest rates will also spike upwards to follow the 10 year rate. This could happen at any time, could be two days from now or two years, it's hard to predict since there's a lot of behind the scenes events which I'm not privy to, it should've happened by now but what's going on in the back rooms in government worldwide.

So this is where the fun starts. All loans in the US are indexed from the interest rates of various US Treasury bonds, for instance mortgages are generally the 10 year rate plus about 2% while short term business loans are keyed off the 30 & 90 day US Treasury rates. When all the UST rates go up, so do the interest rates on all loans, everything from car loans, credit cards, business loans, to student loans, every loan of every duration will carry much higher interest costs. The US is an economy which depends on cheap easy loans & credit with low interest rates, if the rates go up it suffers a stroke and drops dead.

At the same time this also makes it harder & more costly for the government to borrow money and take on debts, the government's budget will need to come back into better balance since it can no longer sell its debts for money as easily as before. Which means raising taxes and/or cutting services, the fragile half-dead economy is given the figurative kick in the groin.

While all this is taking place, currency exchange rates are probably getting a bit out of balance, or maybe a lot out of balance if we're unlucky. Put it all together and we have the recipe for another Great Depression minus the dust bowls.