12:00 AM, July 17, 2011 / LAST MODIFIED: 12:00 AM, July 17, 2011

Sunday Pouch

The big, fat American debt

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Ashfaqur Rahman

Photo: Eldon Doty

In June this year, the total public debt of US stood at $14.46 trillion. This was more than 98% of its 2010 annual Gross Domestic Product (GDP). The US debt increases by $3.86 billion per day and almost $75 million by the hour.
This is a ridiculous amount for any country to be in debt.
So how did USA come to such a pass? Who is she indebted to? And when can she return to a normal state of affairs? Why is President Obama asking the US Congress for a higher ceiling for US indebtedness?
Let us take each aspect separately.
First, what comprises this debt? To put in simple terms, the US national debt is the accumulated amount of money which is owed by the US Federal Government. Another aspect of national debt is the Federal deficit, which is the yearly expense which exceeds the US annual revenue.
Thus, these twin elements make up the US national debt at any point of time. Due to the huge debt owed by the US, Standard and Poor, the influential credit rating agency, has this April downgraded the US credit outlook to "negative."
But the US had incurred public debt since she was born. In 1791, just after the American Revolutionary War, she had the first debt to the tune of $75 million. A dramatic spurt in debt occurred during her War of 1812. The second dramatic growth occurred during the American Civil War. By 1860, it reached $65 million. In 1863, the national debt first passed the $1 billion mark.
During the First World War, US ratcheted up her debts to $5 billion. But after the War it could reduce its national debt by 36%. The social programmes enacted after the Second World War caused a great increase in debt from $16 billion in 1930 to $260 billion in 1950. By 1980 the total had reached $909 billion.
President George Bush presided over a debt burden of $10.7 trillion in 2008. But under President Obama, the US debt increased from $10.7 trillion to the present $14.4 trillion.
The US national debt is the "sum of debts held by the public." This portion is about $9.8 trillion. There is "intergovernmental debt," which is $4.6 trillion. Both these add up to $14.4 trillion.
Now who owns this national debt?
A little less than half of the debt is owed by the Federal Reserve to individuals like Warren Buffet, corporations and states. The rest is to foreign governments.
Foreigners own $4.5 trillion of the US debt, or 32% of the total debt of $14.1 trillion (as on January 2011). The largest holders are the central banks of China, Japan and the UK.
It is well known that a high debt level affects a country's inflation, interest rate and economic growth. For the US it is putting pressure on the value of the dollar. It also means increasing the risk of devaluation or inflation.
The most critical is that it challenges the dollar's role as the world's reserve currency. Thus, if another currency like the Chinese currency or a basket of currencies replace the US dollar as a reserve currency, then the US would have to face higher interest rate to attract capital. This would reduce economic growth of the US in the long term.
The US also faces a series of financial challenges due to its high indebtedness. The population of the US is growing older each year. In order to provide medical and social care it has mandatory programmes like Social Security, Medicare and Medicaid. However, in future, due to indebtedness, it will not be able to provide the money needed.
So, sometime between 2030 and 2040, this mandatory spending will start exceeding tax revenue. The result will be that the US will have no resources for "discretionary spending" like defence, homeland security, law enforcement, education, etc. She will need to borrow more and also resort to deficit spending.
So what is the solution before the US?
The US needs to make a definitive choice now. Either she chooses "bankruptcy" or she raises taxes or cuts mandatory payouts like Medicare, etc. Increasing her dependence on foreign sources of funding, like from China, would make the US less able to act independently.
Do not forget that the US also has to pay huge interest to her domestic and foreign creditors. However, thanks to low interest rates, she is at the moment able to manage. But in case of increase in interest rate to historical averages, the interest cost could shoot up dramatically.
Now, is there a danger level of indebtedness? Many think the level of debt to GDP shows the "red line." Anything above 90% of GDP is crossing the "line." But this is strongly disputed. So there is yet no threshold at which government debts begin to endanger economic prosperity and stability.
However, the moot question which President Obama faces in Congress today is whether he can lift the debt ceiling fixed earlier by Congress. By August 2 this year, the US would reach her debt ceiling and the country would then be in default.
President Obama is still negotiating with his opponents, Republicans and many Democrats, to find a way out of the impasse. He wants to raise the debt ceiling. But the Republicans say that he cannot do this as he must raise taxes. Further, they want him to reduce government expenses, which has bloated and caused this huge debt. To be specific, they say that they want $2.4 trillion in spending cuts. Only then can the Republicans allow him to raise the debt ceiling. His own Democrats call for bigger tax increases to finance the rise in debt ceiling, which the Republicans are dead against.
President Obama is meeting congressional leaders every day till he comes up with a solution. To date, no deal is in sight.
China, the largest foreign creditor with more than $1 trillion in loans to the US, has urged her to adopt responsible policies to protect investors' interests. Moody Investor Services has said that it may strip the gold-plated US credit rating, unless the US credit ceiling is raised.
Failure to raise the ceiling can scare investors and lead to a rise in US interest rates, which can lead to fall in stock prices, thereby pushing the US back into recession. This is likely to cause turmoil in global markets too and affect countries like Bangladesh and India.
A tense political drama is now being played out in the US. The president has called it "decision time." He is against a short-term decision which Republicans want, in order to defer a long-term solution.
The swords are out of the scabbards. The clang of steel against steel from the top US policy makers is being heard. But will there be a winner before August 2? Can the big, fat debt be reduced to a lean, thin one?

The writer is a former Ambassador and the Chairman of the Centre for Foreign Affairs Studies. E-Mail: ashfaq303@hotmail.com

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