Friday, January 16, 2009

The United States will “look like a banana republic” unless it gains control over its budget deficit and federal debt, economist Allen Sinai warned Congress on Thursday.

“The deficit and debt prospects under almost any scenario are daunting,” Mr. Sinai, chief global economist for Decision Economics Inc., told the Senate Budget Committee. “This territory is uncharted, with no real historical analogue to this kind of financial situation for a major global economic power.”

Asked by committee Chairman Kent Conrad, North Dakota Democrat, whether the U.S. government’s creditworthiness is at risk, Mr. Sinai replied, “Unequivocally yes.”

Richard Berner, chief U.S. economist at Morgan Stanley, told the committee one measure of America’s creditworthiness — credit default swap spreads — already shows some deterioration. The worse a nation’s credit rating becomes, the more its CDS spread rises. U.S. sovereign CDS spreads have widened to about 0.6 percent from 0.1 percent last summer, Mr. Berner noted.

“So the message is that you ignore global investors at your peril,” he told the committee.

From 2002 to 2007, foreign investors financed nearly 75 percent of America’s budget deficits, according to Office of Management and Budget reports.

A two-year, $800 billion economic-stimulus package, according to Mr. Sinai’s forecast, would generate a $1.8 trillion budget deficit in fiscal 2009 and $1.3 trillion next year. Measured as a percentage of gross domestic product (GDP), these deficits would be about double what occurred under the Reagan administration in the 1980s, Mr. Sinai said.

Budget deficits for the 2011-19 period would not be much different, averaging $1.2 trillion per year.

These relentless deficits will cause publicly held government debt to soar. Debt held by the public amounted to about 40 percent of gross domestic product (GDP) at the end of 2008. By 2013, this ratio will rise toward 60 percent, said Mr. Berner of Morgan Stanley.

“Barring action to fix our entitlement programs, that ratio will jump over 100 percent by fiscal year 2022,” Mr. Berner said.

“History shows that such a jump in debt may boost debt service at the expense of other needs,” he said.

Over the next 10 years, debt will be rising faster than GDP, burdening future generations with interest costs and debt repayment that almost certainly will lead to much-diminished U.S. economic growth and a reduced standard of living, Mr. Sinai warned.

“A step down the line of diminished economic power and wealth has been taken,” he said.

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