The Dire Consequences of the U.S. Budget Deficit

[Feuer Frei!]

The United States is running an unsustainable budget deficit. The International Monetary Fund calculates that it will come to 10.8 percent of GDP in 2011, worse than the 8 percent projected for the group of advanced G20 countries and far worse than the 2.5 percent projected for the emerging G20 countries.
The future doesn't look much better. The IMF calculates that the gap between the current budget path and a sustainable budget path is larger for the United States between now and 2016 than for any other country bar Japan.
Deficits for a few years don't matter. The United States can borrow easily to cover its budget gap thanks to the dollar's status as the leading reserve currency. But sustained deficits do matter. They add to the stock of national debt, driving up the cost of interest payments and draining the government of resources.
When cumulative deficits drive national debt to around 90 percent of GDP, a country's growth rate starts to suffer. On current projections, the United States will hit that level within a decade.
Sustained U.S. deficits may also create doubts about the U.S. commitment to repay creditors. The more the U.S. government owes, the more tempting it is to reduce the value of those obligations via inflation or a depreciating dollar.
The fear that U.S. officials will succumb to these temptations, justified or not, may dampen investors' willingness to hold U.S. Treasuries, threatening the dollar's reserve currency status.
At some unpredictable point, investor jitters could spark a rush for the exit, driving U.S. interest rates up and causing the dollar to fall sharply.
How pressing is this risk? CFR's Center for Geoeconomic Studies tracks the foreign-exchange reserves held by BRIC central banks (PDF); the data show that faith in the dollar may already be waning.
China, for example, held 70 percent of its reserves in dollars in 2005, but the share has since fallen to 63 percent. Another CFR chartbook underscores the importance of foreign governments' confidence in the dollar (PDF).
More than a third of U.S. government debt is in the hands of foreign official investors. If they were to sell even a small share of their stake, the United States would be in trouble.


SOURCE


Dire indeed.