How can such enormous debt be sustainable and what happens to the world economy if the U.S. defaults?

BY Paul Solman  February 13, 2008 at 6:03 PM EST

Question/Comment: I am a Canadian. Unfortunately, 87 percent of our trade is with America. Consequently, U.S. recessions are felt more deeply in Canada. However, my questions are about the American debt. My understanding is that the debt could reach $10 trillion by the time Bush leaves office. Does a debt that huge not then severely restrict stimulus options for the new president and Congress?

Secondly, is it not likely that the Fed, sooner or later, will have to raise interest rates in order to sell more debt and to defend the dollar from tanking and thereby slowing inflation?

Finally, how can such enormous debt interest charges be sustainable and what happens to the world economy if the U.S. defaults?

I realize, Mr. Solman, that I have posed a lot of questions to you. I much appreciate any clarification you can give me on what, in my view, is an enormous conundrum that, for some reason or other, seems to be off the radar of economists and those running for office.

Paul Solman: Yes, a lot of questions indeed, Mr. Cummings. But not to worry. I have a lot of answers. Whether they’re worth the bytes they’re printed with is another matter. You be the judge.

First, the debt: “The Outstanding Public Debt as of Feb. 13, 2008 at 11:01:52 PM GMT is: $9,252,481,323,143.39,” according to the U.S. national debt clock.

You Canadians might take some pride in the fact that this would have been well over 10 trillion Loonies as of a year ago, but slightly less than 9.2 trillion Loonies today.

As to restricting options: yes, the more you owe, the less easily you can lower your country’s interest rates for one simple reason, which you suggest in your second question: the lower the interest rate in the U.S., the less attractive our IOUs are going to be, denominated as they are in U.S. dollars. When foreigners (or even Americans) start selling their dollar investments to diversify overseas in other currencies, that means, all else equal, that the U.S. has to pay a higher interest rate to get them to lend to us. We’re between a rock and a hard place, that is.

(The connection to inflation is that when the U.S. currency drops in value, goods from abroad, like oil, become more expensive and goose prices. That is inflation.)

As for Question No. 3: Is the deficit sustainable? As long as the world’s savers are willing to prop it up, it is. But one thing to reassure you: the U.S. is not going to default. We’ll inflate the currency by creating more dollars, as the Fed is doing when it lowers interest rates. But we’re not defaulting. Not in my lifetime. (I’m 63.)