Why America's debt is a risky foreign affair

In the throes of the Great Depression, Franklin Roosevelt tried to pump up the economy with deficit spending. He also used a memorable phrase to sell the idea to a wary nation: "After all, we owe it to ourselves."

It was a clever summation of why federal deficits aren't always bad. When the government goes into debt, the interest it pays on that debt used to flow back to the nation's own banks and individuals.

That's not nearly so true today in the United States, and it's troubling. Left unchecked, mounting deficits are never good news. Making it worse, the US is shipping a rising portion of interest payments on that debt abroad. That means less of that money stays at home to be spent or invested. And it also can weaken confidence in the dollar.

Already, foreigners receive more than a third of the interest paid on the $4 trillion in federal debt now held by the public. "We are mortgaging America to the Japanese," says Leonard Burman, an economist at the Urban Institute in Washington.

Add to that the Chinese, the Taiwanese, and people in many other nations who own US Treasury bonds.

The problem isn't foreigners. By lending their money to Uncle Sam, they've kept interest rates low and indirectly helped finance US economic growth. The real culprit is America's mounting debt. And with Washington on a pre-election spending binge, the debt outlook is bleak.

"Our children and grandchildren will pay higher taxes or get reduced government services to pay off these debts," warns Mr. Burman.

As of June, foreign central banks and other governmental institutions plus foreign private investors owned $1.35 trillion of US Treasuries, or some 37.6 percent of the total. They also held $744.5 billion of agency debts (Fannie Mae, Freddie Mac, etc.), or 12.9 percent of their total.

"People say we owe [the debt] in dollars. So we can just print more dollars," says Jane D'Arista, an economist with the Financial Markets Center, in Philomont, Va. But that sanguine view misses a key point, she argues. As the outflow of US resources grows, the danger of a run on the dollar increases.

Last August, the Congressional Budget Office - the scorekeeper for Congress - calculated that the federal debt would grow to $5.4 trillion by 2013. Interest on the debt would amount to $305 billion that year. That assumes the interest rate on 10-year Treasury bonds rises to 5.8 percent. It's 4.9 percent today.

That CBO estimate, though, presumes today's tax law stands as is and that none of today's tax cuts and credits now scheduled to expire by 2010 would be extended. All this is unlikely.

A group of Washington budget analysis groups, the Committee for Economic Development, the Concord Coalition, and the Center on Budget and Policy Priorities (CBPP), have applied more realistic assumptions. They estimate larger deficits ahead, a $9 trillion federal debt by 2013, and $473 billion in interest payments that year.

That's huge.

Interest payments would consume 15 percent of all federal revenues, as opposed to 8.8 percent today. Interest costs would be equal to 72 percent of the projected defense budget of $660 billion in 2013.

Worse, if 40 percent of that debt was owned by foreigners, the US would be shipping abroad some $189 billion in interest payments that year. This would not retire a penny of the debt owed foreigners.

"The economy won't fall apart because Washington behaved badly for a decade," says Richard Kogan, a budget expert at the CBPP. But "at some point, things collapse."

The trio of budget groups, in a joint statement Sept. 29, called for Congress and President Bush to develop "a realistic plan for putting the nation's fiscal house in order."

Since then, however, the fiscal situation has deteriorated.

For example, last Tuesday, Congress added a prescription-drug benefit to Medicare. The CBO estimates it will cost $394 billion over the next decade, adding to federal budget deficits and the federal debt.

The budget already has slid from a surplus of $127 billion in 2001 to a deficit of $374 billion in the fiscal year ended Sept. 30, the largest deficit ever in dollar terms. This year it could rise to $525 billion, estimate economists at Goldman Sachs, an investment-banking firm.

Burman notes that if costs of the prescription-drug program grow at the same projected rate as Medicare overall, the drug bill in the 2014-23 decade will reach $1 trillion.

Just how much extra spending Congress will approve won't become clear until it comes back into session in December to again consider a long-delayed appropriations bill. The legislation covers more than a third of the federal government's expenditures and is laden with costly goodies to please constituents. Congress is also considering tax cuts for corporations.

Even the conservative Wall Street Journal is calling it "the GOP's Spending Spree."

Since 2001 and the start of the Bush administration, total federal expenditures have grown 16 percent. In fiscal 2003, federal spending topped $20,000 per household for the first time since World War II. That sum is adjusted for inflation.

More than half of all that new spending is unrelated to defense and the 9/11 attacks, according to Brian Riedl, an analyst at the Heritage Foundation in Washington.

Late last month, a coalition of Democrats and Republicans in the Senate did quash an energy bill costing $31 billion over 10 years. But Republican leaders will revive energy legislation and its subsidies for various sources of energy next year.

So more deficit spending and bigger piles of debt lie ahead.