Can the U.S. Survive Large Deficits and Debt?

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Troy Timmerman

Economics 367.02

Professor B. Bellner

May 31, 2012

Abstract

Can the U.S survive the large deficits and debt that it has continually had in recent history?

The answer is no. So what does the government need to do to fix the economic mess that it

has gotten itself into? This paper will discuss whether austerity measures would fix the

federal government’s current financial problems. Another option that will discussed in this

paper is whether the government should let the ratio of GDP growth relative to the interest

rate of the debt reduce the apparent size of the debt. A Third option discussed, is whether

or not the U.S. government should monetize their debt. The fourth possibility is to raise

taxes. The fifth and final possibility that will be discussed is if some combination of the

above would work better and be more effective.

Can the U.S. Survive Large Deficits and Debt?

Today in the United States there is a heated debate brewing on whether the yearly deficits

that the federal government is creating and the debt that continues to balloon will be

sustainable into the future or will the U.S. need to make drastic changes to maintain a

viable economy in the long run. One problem in this debate is that politicians do not want

to tell their voters that there will be cuts to anything. There is an applicable quote by

President John Adams, “There are two ways to conquer and enslave a nation. One is by

sword. The other is by debt.” (Timeless quotes, 2011) Has the economics of this country

changed that much? Was President John Adams wrong when he said that quote? Some

argue that drastic austerity measures need to be taken and the sooner the better. Others

insist that as long as the growth rate of the Gross Domestic Product (GDP) is larger than

the interest rate on the debt that everything will be fine because the effective payments on

the debt are getting smaller in comparison to the GDP (Taylor, Proao, de Carvalho &

Barbosa, 2012). Yet others say the U.S. government should monetize the debt, which

means that the treasury should print more money and release it into circulation so that the

U.S. government will pay off their debts with money that is not worth as much as the

money that they borrowed. The downside is that this also means that the money that the

general public holds is also worth less and it makes everything that people buy cost more.

This is otherwise known as inflation. Others think that the government should increase

taxes to solve the debt crisis. Still others think the federal government should use

combinations of increasing the GDP and monetizing the federal debt and raising taxes. In

this paper these options will be discussed and will conclude with which changes the

country should make to get this nation out of the deep hole that politicians from both

parties have placed it in and what could happen if we do nothing or the possible

consequences of following each of the previously discussed options.

What could the U.S. buy for $454 billion? (Interest expense, 2012) Nothing because that is

what the U.S. government spent last year for the privilege of being in debt. This nation

could afford to help more of the truly needy among us or could have had many helpful

programs but that money is spent and nothing is gotten in return. The interest payment that

the federal government makes on the debt is the fastest growing part of federal spending.

For the past three years politicians have been embarrassed by the amount of federal

spending and have refused to pass a budget which they know would have put them on the

record as having supported the current level of spending. They knew that when the next

election came around their opponent would have pointed to their support for the spending

levels and that the majority of voters would not support them. If the $454 billion is the

interest payment when interest rates are at historically low rates, what happens to the

interest payments on the federal debt when interest rates return to more normal levels? In

2011 the interest rate that the U.S. government paid on the debt was 2.826 percent but in

2001 the interest rate that they paid was 5.743 percent (Interest-bearing Debt, 2012a,

2012b). Would the debt interest payments increase to $900 billion if the interest rates were

to return to previous levels? With the total federal revenue of $2.3 trillion in 2011, if the

debt interest rate were to increase back to more normal levels the debt payment would be

almost half of the total revenue of the federal government (Federal Government Revenue,

2012). At that point the federal government could not afford many of the very basic

programs that most people agree are essential. Those that argue that any cuts to any

programs will hurt people should realize that the cuts that would need to be made in the

previous circumstance would be much more drastic. This is where the logic comes in that

says that the sooner that changes are made the less drastic those changes have to be.

Another thing that affects the interest that the federal government pays is our credit rating

as a nation. Standard & Poor’s has already lowered the government’s credit rating from

AAA to AA+ and Moody’s and Fitch’s have promised to lower their rating of the