There Is No Looming U.S. Debt Crisis

(Bloomberg Opinion) -- As concern mounts about the rising levels of U.S. government debt, it’s important to keep in mind two principles that are not quite opposing but not quite complementary: First, there is no looming debt crisis. Second, the U.S. needs to address the growing federal deficit over the medium term in a deliberate way.

To be clear, the pandemic has created an unprecedented shock, and the economic outlook is difficult at best. If there are Depression-like levels of unemployment for an extended period, then it would be a profound economic crisis and public debt will explode. That’s very different from saying that public debt will cause an economic crisis. There are a number of reasons to think that it will not.

First, for nations that issue debt in their own currency, excessive levels of public borrowing tend to produce exchange-rate crises rather than debt crises. The reason for this is straightforward: If debt service becomes unmanageable through taxation, the country can always print more currency to meet its obligations.

This is not the same as saying, as some advocates of Modern Monetary Theory do, that a country with its own currency can always pay for any spending by printing money. Instead, it is to suggest that countries experience the negative effects of excessive debt in different ways — depending on how that debt is financed.

Many developing nations borrow in dollars, for example, and countries that borrow in a foreign currency can be forced to default on that debt if they cannot raise enough revenue to purchase the needed dollars in foreign-exchange markets.

Countries that borrow in their own currency do not face this risk. They do, however, face the risk that printing too much money will cause the value of their currency to fall sharply relative to their trading partners.

These kind of exchange-rate crises were common in Europe before the adoption of the euro. They remain unlikely for the U.S. That’s because, especially in times of uncertainty, there is rising global demand for dollars and dollar-denominated debt. That demand, in turn, is driven by the unique role the U.S. and the dollar play in international finance.

Consider that, as the pandemic spread in early March, demand for the dollar skyrocketed and its value spiked to record levels. It has retreated a bit since then, but remains near record highs. That same surging demand sent the prices on 30-year U.S. Treasury bonds soaring, and so the yield on those bonds collapsed to record lows.

Which brings up a second reason the U.S. needn’t worry about the debt in the near term. The strong appetite for Treasuries means that the U.S. government can meet its debt servicing needs by issuing new long-dated securities that lock in a low interest rate for a decade or more. That low rate ensures that the federal government will not face spiraling debt-service costs even as the total amount of debt rises sharply over the next few years.

Is it possible that the global appetite for dollars and U.S. Treasury bonds could subside over the next few years, forcing the U.S. to make some difficult choices about how to reduce its debt? It is. Even if government borrowing costs are low, rising interest rates could potentially slow private-sector investment or sharply increase the trade deficit.

The good news about this scenario is that, if it comes to pass, it would mean that there was a worldwide economic recovery. Only then would savers be willing to forgo the safety of dollar-denominated assets.

One last point: The U.S. is fortunate relative to other advanced countries because federal government spending is relatively low. Reforms to both the tax system and entitlement benefits could bring the budget into balance without sharply raising rates or reducing the safety net for the most vulnerable.

Neither reform is easy, but both are possible. It would be useful, or course, to start thinking about these tradeoffs now. In the meantime, there is no reason to fear a debt crisis.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.

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