The United States enters the twilight zone

By Cate Long
May 3, 2012

ZeroHedge points out that the amount of U.S. debt outstanding has just surpassed the latest reading of our gross domestic product:

There is nothing quite like a $70 billion debt auction settlement at the last day of a month to bring total US debt to a record $15.692 trillion, which happens to be just $600 billion shy of the $16.394 trillion debt ceiling … And now that we know what Q1 GDP was at the end of Q1, or namely $15.462 trillion, it is simply math to divine that today alone total US/debt to GDP rose by 50 bps to a mindboggling 101.5%.

Now there is a whole school of thought, which counts New York Times columnist Paul Krugman among its leaders, that says that despite the amount of debt the federal government has incurred, more government spending and debt are needed given the stagnant state of the economy. Krugman elaborated on this idea in a recent interview with Julian Brookes of Rolling Stone:

A lot of people find emotionally unacceptable the idea that economic suffering on this scale could have a relatively trivial cause. But this has happened again and again through history. And it could be fixed fairly easily, by having government step in and spend.

The U.S. economy sits on a knife’s edge of slowing growth coupled with increasingly heavy debt loads. Fitch Ratings issued a report yesterday saying that U.S. fiscal policy likely increased growth by about 4 percent over the past two years through debt-financed stimulus spending and tax cuts. However, the report drew no firm conclusions about future policy:

This deteriorating debt profile heightens the pressure on the U.S. government to wind down fiscal stimulus, which is necessary to addressing U.S. indebtedness but creates a drag that may weigh on future U.S. economic growth.

The very high deficits of the last few years have led to unprecedented levels of government indebtedness, which will weigh on the federal government for years and require contraction in spending. Furthermore, while low [interest] rates clearly benefit borrowers, at the same time, they hurt savers. While there have been some recent signs of improvement in the economy, future reductions in fiscal outlays and effective limits to further accommodative monetary policy raise questions about the timing and strength of the recovery in the coming years.

Krugman advocates sustaining economic growth through increasing government debt issuance. The data from Fitch shows that deficit spending does improve economic activity but suggests this is no longer a tenable approach. I think the more critical element of discussion that Krugman touches on but does not make central is that the government must stand ready to alleviate the “economic suffering” of those most affected by the weak recovery. Helping those who are homeless and unfed is an achievable goal. But propping up the entire economy by issuing more debt can’t be sustained for much longer. The U.S. has entered the twilight zone. Rushing headlong into the darkness is a risky approach.

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