U.S. Debt: Fatal Millstone or Humdrum Fact of Life? : Finance: Federal borrowing will balloon despite new budget. But dangers are misunderstood, experts say.

Remember the national debt, that multitrillion fiscal embarrassment, which Ross Perot once compared to a “crazy aunt” hidden in the basement?

Despite all the tax hikes and spending cuts in the new U.S. budget accord, the overall national debt--now at least $3.2 trillion--is expected to balloon by another trillion dollars in the 1990s.

Interest payments on all that red ink will cost more than the defense budget by 1997, according to congressional estimates. Federal borrowing, meanwhile, will remain vast--gobbling up cash that might otherwise go to private investments that spark economic growth and create jobs.

“Less has been accomplished than the legislators are taking credit for,” maintains Mickey D. Levy, an economist with NationsBank in New York.

Yet if the national debt has become sort of a national punching bag--grist for everyone from stand-up comedians to political opportunists to foreign leaders--the real dangers it poses often are misunderstood, many analysts contend.

By virtually all accounts, it is a financial albatross and threatens increasing turmoil in the coming years. But agreement ends there. How much debt would trigger a panic is unknown. Investors are still happy to lap up Treasury bonds by the billions, as they did in an auction last week.

Even the debt’s exact size is arguable, and its role in making America dependent on foreign investors often is exaggerated, statistics suggest.

Take the much-ballyhooed threat from overseas. There have been ominous warnings that foreign investors could get fed up with America’s fiscal imbalances and dump their U.S. Treasury securities, sparking a financial debacle.

In fact, 83% of the debt is held by Americans--banks, insurance companies, private individuals, local governments and others--according to a May study by the Congressional Budget Office. For all the anxiety about foreign influence, the overseas share has not increased since 1980.

“Thus far,” reported the CBO researchers, “these fears have proved ill-founded.”

Holders of U.S. Treasury securities--sold as bonds, notes and bills--are helping finance the national debt whether they realize it or not. Moreover, they make money on the interest, which ripples back into the economy.

There also is confusion about the debt’s magnitude.

It has been popularly pegged in the $4-trillion range. But many economists say that figure is misleading, because it lumps together $3 trillion plus in public debt--owed to private lenders and sold in credit markets--with another $1 trillion in trust funds that the government owes for pensions, public works and other programs.

“There’s nothing you can do with the $3 trillion but pay it or default,” observes James F. Smith, an economist at the University of North Carolina at Chapel Hill.

The other obligations may have tremendous significance, but in political terms, not economic. “They’re moral obligations,” Smith said. “They’re not legal obligations.”

Certainly, the millstone of debt could grow weighty enough to disrupt financial markets, propelling interest rates skyward and triggering a global crisis.

“But we can’t say what the trigger point would be,” says Ross DeVol, an economist with the WEFA Group in Bala-Cynwyd, Pa.

Indeed, for all the agonizing and political finger-pointing about the burden of red ink, it has become a humdrum fact of life in global finance.

Investors remain content to buy Treasury securities, with little worry that the money is safe. Just last week, the Treasury Department auctioned $38.5 billion in securities to cover the debt, an event so routine as it drew only modest public attention.

In the aftermath of the recent deficit-cutting debate, however, economists are examining a key question about the national debt: Will it continue to outpace the growth of the economy, as it has since the 1970s?

A reversal in the trend would ease pressure on the economy, freeing up cash for private investment, boosting confidence and providing the government with more leeway in how to parcel out its money.

The answer, which depends on assumptions about future spending cuts and rates of U.S. economic growth, is in dispute.

A new WEFA Group analysis found that the total debt, now 52% as large as the U.S. economy as measured by gross domestic product, would gradually shrink to 47.6% by 1998, largely as a result of the new budget plan. To some observers, this is reason for qualified good cheer: Under the old law, WEFA forecast the debt approaching 55% of the economy by 1998. Others had even gloomier predictions.

“It’s a real change,” said John P. White, the architect of Perot’s deficit-cutting campaign blueprint, and later an adviser to candidate Bill Clinton. “It really is a trend in the right direction.”

Economists at DRI-McGraw Hill in Lexington, Mass., concluded just the opposite of WEFA in their own computer simulation of the budget plan’s effects on the economy.

Today’s massive debt load, they found, will swell to $4.6 trillion by 1998--an amount equal to 57% of the entire economy, diverting more and more of the nation’s savings to paying interest on the debt rather than investing in private enterprise.

Each year’s budget deficit adds directly to the national debt, and even advocates of the White House program expect continued deficits in the $200 billion range. The colossal growth in budget deficits since the early 1980s is the reason the national debt has expanded so rapidly, and will continue to expand for the foreseeable future.

The DRI economists are skeptical, for example, that the federal government will realize the $496 billion in deficit savings promised by Clinton.

“We’re still borrowing more money than we can afford, and debt is still growing faster than the economy,” declares David Wyss, a DRI economist.

The current episode of vast debt is not the nation’s first. But in a troublesome departure from the past, it is the most stubborn.

The red ink became an ocean during World War II, for instance, when the United States desperately scrambled with the costs of mobilization. By 1946, the national debt was larger than the whole economy. Unlike today, however, the World War II debt burden plunged in the postwar years, reaching a low of 24.5% of the economy in 1974, government figures show.

It hovered in that range, then exploded in the 1980s, along with a sharp rise in U.S. spending on health care, defense and other programs. The debt dipped just slightly in the late 1980s as a share of the economy, before rocketing upward with the onset of recession in 1990.

To reduce the national debt in absolute terms would require that the U.S. budget run in surplus, a state of affairs widely viewed as pie in the sky in the current political climate where major spending cuts and tax increases prompt bitter opposition.

“It would wreak so much suffering in the streets, it would be impossible to bring it down to zero in the short run, even within five years,” said James C. Van Horne, a finance professor at Stanford University.

In the meantime, the debt takes a genuine toll on the economy. The interest payments are a relentlessly growing share of federal spending--$199 billion this year--more than the combined budgets of Medicaid, food stamps, welfare and child nutrition, according to the House Budget Committee.

By 1997, projected interest payments of $253 billion on the debt would surpass the defense budget and soak up 15.1% of all federal spending, according to the budget panel.

“Interest gets added into the debt, and you pay interest on interest--and over time that compounds on you,” said Joseph W. Duncan, corporate economist at Dun & Bradstreet and president of the National Assn. of Business Economists.

“It’s a good news, bad news story,” he says of the new budget program in Washington. “The debt is less than it would have been otherwise. But it’s still growing.”

The government’s voracious appetite for debt financing keeps interest rates higher than they otherwise would be, economists say. The mere expectation that Clinton would curtail the deficit has been enough to push down long-term rates by more than one percentage point since late last year, WEFA’s DeVol estimates.

In extreme cases, Third World countries have reacted to such pressures by throwing up their hands and refusing to pay back the money. Such an option is hard to envision for the United States, analysts contend, because it would batter U.S. credibility in global markets and the nation’s enduring status as a world economic leader.

More conceivable, some believe, is that America will ultimately tire of its debt burden and the limits it places on domestic spending. Political leaders might then be tempted to “monetize” the U.S. debt, meaning they will allow inflation to re-enter the economy and repay the debt in cheaper dollars.

“That’s the ultimate danger of too high a debt,” Stanford’s Van Horne said. “There’s a natural tendency” for debt-saddled governments to ease the pain by printing more cash.

Others criticize the political discourse on debt and deficits for focusing too much on specific dollar amounts and failing to consider a key issue: whether the nation is targeting its money in areas that will pay off down the road.

After all, nobody would complain if a corporation went into debt to buy new technology that ultimately made it a more powerful, efficient competitor, points out Levy of NationsBank. “Does it use the money for a year-end Christmas party or to improve productivity?” he asks.

What’s worrisome about the national debt, he argues, is that it is fueled by the rising costs of spending programs that do little to increase the country’s productivity and ability to compete in the world economy. “That should be the real focus,” he said.

Yet as long as the national debt hurtles ever higher, there will be no shortage of people who focus on the numbers. Even optimists expect the debt to grow rapidly after 1998, unless the nation manages to curtail health care costs.

“It’s still a great burden on future generations,” said David M. Jones, chief economist at the Aubrey G. Lanston & Co. investment firm in New York. “You have to ask yourself,” he said of the budget deal, “Did we try hard enough?”

The Pace of Borrowing

To pay the debt, the government must borrow vast sums of cash which might otherwise go to private investments that spark growth and create jobs.

In trillions of dollars Gross Domestic Product ‘80: 2.71 ‘92: 5.95 Outstanding Federal Debt ‘80: .702 ‘92: 3.01 Source: WEFA Group