Debt Wish

How significant is the risk that the U.S. will eventually hit a debt crisis? Earlier this week, I noted a new paper by Arnold Kling guessing that it's at least somewhat likely that the U.S. will experience a debt crisis sometime in the next two decades. Yesterday, the International Monetary Fund released its own report on the question. The gist, from The Washington Post, is that America is reaching toward the limits of what investors are likely to put up with:

The IMF estimated a series of probabilities regarding the amount of increased debt a country might be able to sustain without hitting its projected point of no return.

In the case of the U.S., the fund said the odds were roughly three out of four that the country could increase its total debt to some degree without being penalized by investors—logical considering that the debt is steadily increasing and interest rates remain low and steady.

However that probability falls to an even 50-50 if the amount of new borrowing were to exceed fifty percent of GDP—or about $7 trillion given the current, $14 trillion size of the U.S. economy.

That might seem like plenty, except for the fact that under current Office of Management and Budget projections the "fiscal space" may fast disappear. The OMB projects total U.S. debt to jump by about $4.7 trillion in the next five years, leaving little room after that.

Better than expected growth, of course, could add fiscal "space," but another recession could shrink it.

In other words, despite some anxiety, investors don't seem too worried about U.S. debt today. But at the point when investors become more worried, might it be too late? As Kling cautioned in his paper, without some no-kidding signals that the U.S. is working seriously to reduce its debt load, "investor expectations will change at some point. That change in market perception is likely to be swift and severe."