Tuesday, February 3, 2009

Effects of Debt


"Even before Obama walked through the White House door, there were plans for $1 trillion of new debt," said Niall Ferguson, a historian at Harvard who has studied past patterns of borrowing and its impact on national power. He now estimates that some $2.2 trillion in new government debt will be issued this year, assuming the stimulus plan is approved.

"You either crowd out other borrowers or you print money," Ferguson added. "There is no way you can have $2.2 trillion in borrowing without influencing interest rates or inflation in the long term."

Ferguson added that he was particularly struck by the new borrowing because the roots of the current crisis lay in an excess of debt at all levels, from individual homeowners with subprime mortgages to Wall Street banks who let their balance sheets balloon.

"This is a crisis of excessive debt, which reached 355 percent of American gross domestic product," he said. "It cannot be solved with more debt."

While Ferguson is a skeptic of the Keynesian thinking behind Obama's plan - rather than borrowing and spending to stimulate the economy, he favors corporate tax cuts - even supporters of the plan like Zedillo and the economist Stephen Roach called on the White House to quickly address how it will be paid for in the long term.

"It's huge," said Roach, who is chairman of Morgan Stanley Asia. "President Obama has now laid out a scenario of multiyear, trillion dollar deficits."

To make matters worse, he said, the United States "is a savings-short, deficit economy. When we decide to borrow, we're asking lenders from around the world to step up and give us the money."

The stimulus is widely expected to pass, but once it does, Roach said the focus will shift to "who foots the bill and what is the exit strategy. We don't have the answer to either question."

Zedillo, who remembers how Mexico had to tighten its belt when it received billions from Washington to save its economy from collapse in 1994 , was even more blunt.

"People are not stupid," he said. "They see the huge deficit, the huge spending, and wonder what comes next."

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