With the economy humming along, it’s easy to become cavalier about big federal deficits but when the next recession hits — those could make it a lollapalooza.
As often stated, federal deficits greater than $1 trillion dollars — about 5 percent of GDP — are huge for an economy in the advanced stages of an economic recovery and leave policymakers little latitude to further boost spending when the economy hits a speed bump. As importantly, though, Uncle Sam’s incessant borrowing — just like irresponsible home mortgages in the 2000s — could again send financial institutions barreling over a cliff.
Americans don’t save enough to satisfy Uncle Sam’s voracious appetite for credit. To finance the difference, Americans sell foreigners private assets — choice real estate, equities and corporate bonds — and government bonds.
Already IOUs held by the rest of the world exceed 45 percent of GDP and within the next decade, that figure will surpass 60 percent. No major nation has crossed that threshold without enduring wrenching financial adjustments.
America prints the world’s money — foreign central banks hold Treasuries to back up their currencies, because most international transactions go through the dollar. However, bond markets no longer assign a premium to U.S. government bonds as compared to the securities of other low risk sovereigns like Germany — that indicates international creditors are getting less confident about the U.S. dollar and debt.
As deficits keep soaring, we can expect investors to demand higher and higher interest rates on Treasuries. During the next recession that could well force huge tax increases or draconian budget cuts and send the economy into a death spiral. All that would spin defaults in mortgage and corporate debt, and loan defaults would deal a body blow to major banks.
The recent budget crisis required $300 billion in new spending…