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A U.S. Sovereign Debt Crisis?

Author: Jonathan Masters, Deputy Editor
January 23, 2012

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Fiscal policy is set to take center stage in Washington this week as Congress prepares for its conference committee on the payroll tax cut extension (The Hill), and the Senate votes on the contentious issue of raising the debt ceiling (FoxNews) again. The U.S. national debt recently topped $15.23 trillion (USAToday), roughly equal to the size of the entire economy, and has raised fears among some that the country is marching headlong into a debt crisis akin to that of some nations in the eurozone.

What's at Stake

Bond investors have, thus far, been willing to finance U.S. debt at low interest rates despite the country's troubling fiscal outlook. This is because, says the Congressional Research Service (PDF), they believe Congress will make the appropriate policy changes in a timely fashion, not that they support the country's current trajectory. The market's tepid response to Standard and Poor's historic downgrade of U.S. debt last August was a prime example.

Persistent political gridlock with regard to fiscal policy, however, may eventually shake investor confidence, resulting in higher Treasury yields and spikes in the cost of borrowing for U.S. businesses and consumers (PDF). If there were a sudden crisis of confidence, the move out of treasuries could dwarf that of other market flights. An unsustainable debt burden would also jeopardize the dollar's reserve currency status, a benefit which allows the country to borrow at a lower rate and in its own currency.

The Debate

The country's imposing fiscal challenges has led some observers to compare it to European countries stricken by a sovereign debt crisis, such as Greece, Portugal, and Ireland. In particular, a high debt-to-GDP ratio, large running deficits, and a significant reliance on foreign investors correspond with the recent experience of some advanced European economies.

However, several distinctions lower U.S. risk (CMA), including its status as an asset "safe haven" and anchor currency. In addition, the United States can modulate its monetary policy, unlike Portugal for instance, potentially depreciating its currency in order to boost exports. Unlike Greece, which has been in a state of default half the time since the 1830's, the United States also has an excellent fiscal reputation (PDF), is the world's largest economy, and remains able to borrow at historically low rates, notes a CRS report.

Policy Options

Lawmakers must balance the needs of a fragile economic recovery in the short term and the challenge of debt reduction in the long term. Reducing the deficit too quickly could stall the economy while it remains well-below full employment, while running high annual deficits risks losing investor confidence and a debt spiral.

In the Wall Street Journal, Alan S. Blinder outlines four "deficit myths" and says the United States should continue to borrow, perhaps another $500 billion, for "jobs programs, infrastructure projects, even mortgage foreclosure mitigation." This short-term borrowing, he adds, could be paid for "10 times over, with $5 trillion in deficit reduction spread over 10 years—starting, say, in 2014."

Both political parties have failed to produce politically viable deficit reduction plans, writes Ron Haskins at the Brookings Institution. The next president, he recommends, should open bipartisan talks where everything, including taxes and entitlements, is on the table; push for control of Medicare spending along the lines of existing bipartisan proposals; and reform the budget process -- specifically reinstitute "paygo" requirements for all future spending programs.

Background Materials

This report from the Congressional Research Service discusses sovereign debt in advanced economies, the issues for Congress, and the potential implications for the U.S. economy.

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