The growing concern over U.S. debt is worrying

Cyrillus Harinowo ,  Jakarta   |  Wed, 10/08/2008 10:32 AM  |  Opinion

The recent financial bailout by the U.S. Authorities received a mixed response at best. The stock market in the United States and Europe as well as in Asia tumbled following the news about the US$700 billion bailout. The green back also dropped against other currencies. On the other hand, the governments of the G-7 countries responded to the action with unified support. So what went wrong? Why did the market react negatively?

Apparently there was a growing discontent about the level of U.S. government debt and the budget deficit. The current U.S. government debt has indeed reached a worrying level by international standards. As of today, U.S. government debt reached a level of almost $9.7 trillion, increasing by over $1.8 billion every single day.

By the end of President Bush’s term in January 2009, the debt level may approach $10 trillion. As of now, the total limit of U.S. debt is set at $10.3 trillion by Congress but will be increased to around $11.3 trillion once the proposed bailout is approved.

Bush, unfortunately, will leave over $4 trillion in new debt after his eight years. Bill Clinton left the White House with a level of debt of $5.7 trillion, but with a hefty budget surplus during his last three years in office. Therefore, Bush’s presidency adds new debt at an average of $500 million every year. With total GDP in current U.S. dollars at around $14 trillion, the U.S. debt to GDP ratio will be at a level of around 70 percent and is expected to keep rising.

Currently, no international standard has been universally agreed upon. However, the European Union set a good precedent when it was established. Under its constitution, the Maastricht Treaty, established in 1992, “convergence criteria” are applicable to all countries joining the union. The criteria established a limit of 3 percents of GDP for the maximum government budget deficit and 60 percents of GDP for the maximum government debt. In fact, this standard was also later adopted by Indonesian law as our limits.

Although not every member country adhered to these criteria at the beginning of the union (the debts of Italy, Belgium and Greece reached over 100 percent of their GDPs) the criteria were stringently applied to the new members.

In fact, Germany, France and Italy also breached the 3 percent limit on their budget at one time or another, angering the smaller member countries such as the Netherlands.

Japan had a debt to GDP ratio of around 50 percent in 1990, right before the country went into prolonged recession. Due to the frequent fiscal stimulus, the ratio went up to around 99 percent in 1999 and continued to rise until now. In contrast to that development, progress in fact is taking place in many developing economies including Indonesia. The Indonesian debt to GDP ratio has continued to decline from a level of around 100 percent in 2000 to slightly over 30 percent by the end of this year.

Therefore, looking at these “international standards”, there is growing concern about what will happen after the massive bailout by the U.S. government. With one trillion additional debt through the bailout, the U.S. debt to GDP ratio will immediately increase to almost 80 percents of GDP. In addition, the yearly budget deficit will increase the ratio by around 5 percent every year. So if not careful, the next presidency may reach the 100 percent mark.

A debt level of that magnitude may shake the very foundation of the global economy. While the market for the Treasury securities are still good today, we can not expect that they will remain at the same several years from now. Once confidence on the securities is shaken, the value of the U.S. dollar will also experience a free fall.

If we started to hear about the possibility of nonpayment, history would repeat itself. At the beginning of the federal government, the level of U.S. government debt in 1791 was $75 million. The debt itself was a result of consolidation of the states’ debt during the independence war. As a comparison, the “price” of the State of Louisiana that the U.S. government purchased from Napoleon was $15 million in 1802.

Therefore, $75 million was an extremely huge amount according to the standards of those days. At the time, the new (and the first) federal finance minister Alexander Hamilton was pressured not to pay the debt because the debt created an extremely heavy burden for the new federal government.

Alexander Hamilton, however, was determined to have the U.S. government repay all U.S. obligations. The strong statement meant debt regained its value, and in just three years, U.S. government bonds were listed in the “global capital markets” of London, Paris and Amsterdam.

During the life of the U.S. government, the level of debt has experienced ups and downs. In fact, 50 years after U.S. independence, the level of debt was almost completely eliminated. The debt increased significantly every time the U.S. government went to any war. The Vietnam war made the level of debt almost unbearable.

The U.S. government asked the IMF for help twice, in 1966 and 1968, before President Nixon finally declared the suspension of the formal link between the U.S. dollar and the price of gold, ending the Bretton Woods monetary system in August 15, 1971.

What can be learned from history? Global economic stability is at stake once the rumor about the non-payment of the U.S. becomes a louder noise. It is not just the U.S. economy that will suffer, but the all countries will also lose.

Yes it is true that the level of U.S. government debt increases tremendously. It is also true that the burden to the government budget will keep increasing. Given the lessons during the time of Alexander Hamilton, and also the time of Clinton presidency, the U.S. government will be able to weather these difficulties.

With all the support from various countries, the U.S. government has to stand firm in honoring all obligations and explain that loud and clear.