Home > Dire Consequences Await As U.S. Debt Nears A Tipping Point

Dire Consequences Await As U.S. Debt Nears A Tipping Point

August 14th, 2013

debt ceilingGarrett Baldwin: As U.S. debt as a percentage of GDP hovers at levels not seen since World War II, concerns are growing that the American economy is susceptible to a debt crisis in the near future.

Here’s why people are worried: If interest rates return to normal levels of around 5% as the U.S debt approaches $20 trillion, then servicing that debt each year will cost taxpayers $1 trillion.

Does anyone think that the Federal Reserve, as the enabler of all this debt, will be in any rush to raise interest rates?

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Following Europe’s example, the U.S. debt-to-GDP ratio hit 105.6% in 2013, a perilous level that has long-term repercussions for the world’s largest economy, according to Standard & Poor’s. By 2016, right around the time that Hillary Clinton will be running in earnest to be president, the ratio will likely hit a staggering 111%.

But how much debt is too much debt? And what are the pitfalls facing the United States in the future? Both questions remain hotly contested among economists, despite a wide acceptance of a “tipping point” theory both by politicians and ordinary Americans.

Reaching a debt tipping point means that U.S. economic growth would remain substantially weaker than historical norms. That could lead to other dire economic consequences, such as inflationary pressures and a weak dollar.

With the U.S. borrowing $3 trillion in 2013 to service existing debt, it’s important to examine what a high debt-to-GDP ratio means to the U.S. economy, and, more importantly, your money.

U.S. Debt: The March to $20 Trillion

With a debt-to-GDP ratio above 100%, the United States still maintains an AA+ credit rating following its first global downgrade in August 2011. But concerns about huge deficits and increasing borrowing levels have the potential to put any credit rating in jeopardy, even one for an economy that owns its own printing press and isn’t afraid to use it.

This year, the U.S. will run a budget deficit close to $850 billion, while it requires another $1.2 trillion in net-borrowing (the difference between new debt issued and debts retired) to service and retire maturing debt.

Whether such outrageous levels of debt will lead to a funding crisis is the subject of steep policy debate among leading economists.

In 2010, economists Carmen Reinhart and Kenneth Rogoff released a well-known and highly regarded paper, “Growth in a Time of Debt.” The authors concluded in their study that “median growth rates for countries with public debt over 90% of GDP are roughly 1% lower than otherwise; average (mean) growth rates are several percent lower.”

Simply put, any nation with a debt-to-GDP ratio above 90% will have a lower-than-average growth rate. Like what we’re seeing during the current Obama recovery.

In fact, in early 2013, economists David Greenlaw, James Hamilton, Peter Hooper and Frederic Mishkin concluded that even debt levels lower than 90% are risky. Their tipping point level: 80%.

Of course, other economists would argue no theorem can determine a detrimental level of debt. Rajeev Dhawan of Georgia State University made this very argument in 2010 while citing Germany’s ability to roll over portions of its existing debt without any serious challenges.

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