Still trying to get my head around this, but it's been seriously argued in these august pages of dkos that it's a great idea! to run deficits that will, in my opinion, lead to interest payments that will eventually break us.
We used to be able to run higher deficits, as we did following World War II. But that was when we were on the gold standard, and when our dollar was beginning an uncontested reign as the world's reserve currency.
Now, we are no longer on the gold standard, and some of those--most importantly, China--who used to support our dollar (allowing us to run deficits like Greece's and Spain's), seem to be cutting their losses and selling off their US Treasury securities. If the world continues to sell our securities, and China keeps making agreements to denominate trade in the renminbi instead of the dollar (as they've done with some countries), then we'll no longer be the world's reserve currency, shielded from the effects of our spending. We'll have to raise interest rates, which means, um--PAYING those interest rates. Some think we can run a deficit-to-GDP ratio the size of Greece's. Really? If so, then what deficit-to-GDP ratio, or amount of debt, IS too high?
Some argue that since we ran higher deficits than today's after World War II, we still can. I argue that we used to be on the gold standard, and we used to have Asian central banks and other buoying our dollar's value, by buying up Treasury bonds, as alluded to above the fold.
In 1971, we went off the gold standard, after our balance-of-payments deficit with Europe led to French redemption of too much gold, in exchange for their dollars. In the decades since, we cruised along unfazed, our dollar still buoyed by the Asian central banks and the oil sheikhdoms, buying our treasuries to keep the dollar afloat. But now, China has cut its holdings of our treasuries by some $45 billion since last May, with a $34 billion cut last December. Britain and Japan have bought more, but as the last link shows, there was a net drop in foreign holdings of US securities of $53 billion, meaning that others have been selling too, not just China. China has also, through the SCO (Shanghai Cooperation Organization), struck deals with Brazil, Argentina, and Malaysia, to denominate their trade in renminbi instead of the US dollar. This is all part of a concerted effort on China's part, years in the making, to envision (and put into effect) a world where the Dollar is no longer the world's reserve currency.
Will the selloff will continue, becoming enough of a rout to dislodge the Dollar permanently as the world's reserve currency? I think it's happening right now, as we speak. I certainly could be wrong; it might not continue. But I think that China is, very gradually, climbing down from so much reliance on their dollar stores. A 5% cut in their holdings in 2/3 of a year isn't precipitous, but it's something. If it continues, then... (our rates, and therefore our spending on debt servicing, will have to go up.)
I do think that America will remain an important economy in the world, just as down-sized Britain's and France's have, though they no longer have their empires. Even America's currency will probably remain important, after its fall. But that fall is going to bring changes.
One of those changes will be to our deficit spending. We used to be able to deficit spend helter-skelter, with no regard for any ill effects; but this was because the Dollar was the world's reserve currency. This sheltered us, as the Economist has mentioned many times, from many a painful readjustment, as interest payments to service our debt would have otherwise become too great to bear, and we'd have been forced to tax, or cut spending. But we've been able, until now, to keep our interest rates on our treasuries absurdly low, lower than we should have gotten away with, only because China and Japan and others have run these large balance-of-payments deficits with us, and have needed to buy our treasuries to keep their own store of dollars afloat. Now that our demand is down, though, that's weakened somewhat. Also, the simple fact is that China has divested from our bonds. The world as a whole has cut its holdings, too. That means that, if we want to attract creditors to back our spending, we must raise our rates, before too long (we'll see over the next year or so, whether this is a drastic trend in the making). When we do, we'll have to spend more and more just to pay the debt.
Bill Mitchell, in his blog, says it's ridiculous to assign a one-size-fits-all amount to debt or deficit-to-GDP ceilings, such as the Eurozone forced (a 3% maximum deficit-to-GDP ceiling, which Greece couldn't meet). He also mentions that England ran 300 percent debt-to-GDP ratios after World War II, and came out fine. I don't claim he's wrong about everything--in fact, his blog provides a nice rebuttal to many of my own thoughts--but I do know that England's tax rate, at least, was FAR higher for the rich in particular. Tax exile was a peculiarly English invention (many of your favorite rock and roll bands spent many a year in France, to avoid English taxation, and you may have heard of a song called "Taxman," by the Beatles).
More to the point, though, Bill seems to discount a tendency that I find very self-evident indeed: that when creditors don't want to buy your bonds, and sell them off as China did, above, you must raise your rates to attract them back. And that when you do, you must service that debt, and what is more, you must make it a priority to do so. Governments cannot declare bankruptcy and default on their payments to their creditors, the way credit-card holders do (default is such a calamitous decision, that few seriously thinks that the United States would EVER do so, even in the most dire straits). So we will raise rates; then we'll have to pay more; and, though many pooh-pooh the idea that 6% or 12% deficit-to-GDP ratio is serious, no-one has told me, "well, if it hits figure x, THEN we should worry." As the New York Times just reported (The New York Times National Edition, Wednesday, February 17, 2010, "Party Gridlock Feeds New Fear of a Debt Crisis: A Rising Fiscal Alarm," Front Page), we will be paying
$516 billion
in interest costs, just for servicing our debt, by 2014. Though the article says it's considered unlikely that investors will "dump" their bonds, they do consider it likely that they'll ask for higher rates of return on them "and reduce or stop future debt purchases, threatening the government's ability to finance its borrowing." And again, if China's rate of divestment isn't exactly "dumping" their bonds, it is a significant rate, which will gradually diversify them from dollars. Obviously, if our interest rates needed to be loan-shark rates, they'd eventually be too high; and if anyone were saying that NO debt ceiling was high enough, then please give me and all my neighbors our million-dollar bailouts now.
So: how much debt is too much, then? What volume of debt? What deficit-to-GDP ratio, and debt-to-GDP ratio IS too much, if our present levels aren't?