A Theoretical View of U.S. Debt

(Note: there are opinions expressed in this post that belong to the author and may not necessarily reflect the view of the Global Economics Team as a whole.)

When I get asked what I am studying in college and I reply economics, the conversation will go one of two ways. Either they say "oh so you want to work on Wall Street, eh?" To which the answer is "no, not at all." The second way the conversation may head is toward the evils of the U.S. government's spending habits. Many people are perturbed by the U.S. and our growing debt. It is true that we are spending more money than we have each year, and as many victims of the housing market crash can attest, this is not sustainable. How can we continue to grow our economy if we keep financing our debt with money foreign countries that we have to pay back with interest? Well, I wish I had answers to people's economics questions more often (maybe I should carry around a bag full of economics text books everywhere I go) but this particular question regarding our outflow of money had me stumped. I do not have all the information on this subject, but can shed light on a few interesting relevant points.

First of all, there is no problem with going into debt if the money borrowed goes to a more productive economy. It is similar to any logical investment; you have to spend money to make money! And if there is a lack of funds flowing in to the U.S. economy, then the interest rate will increase and investment will consequently decrease. Since investment is linked to higher economic growth, which for all intents and purposes can be seen a good thing, then borrowing should occur if the money is directed toward economy enhancing programs. Another problem people have with our debt is the fact that the burden of repaying it rests on the shoulders of future generations. This may seem unfair, but not if you take in to consideration that the money borrowed helped create a higher standard of living for that generation, and they may therefore be better equipped to repay.
Second, it is important to keep in mind that our debt may not be a perpetual spiral that will only get bigger and bigger until we collapse and become a third world country. In the 1980s the U.S. dollar was appreciating and interest rates were coaxing foreign investors over. This created a current account deficit and a capital account surplus. This surplus/deficit tango we found ourselves in has persisted and attributes to our "debtor" status. However, if foreign investors no longer find U.S. financial securities desirable, current account will increase, capital account will decrease and our debt will shrink. We will find ourselves debt free and even lending money to other debtor nations, however we will have weak currency and low economic growth. Which situation is more desirable? That is not for me to say, it is up to our ignorant politicians to decide.

Reference:
Steven Husted and Michael Melvin (2004): International Economics sixth edition.

(This was posted by Trevor Murphy-Mannix)