How Things Could Get Really Bad
I have argued that the current recession, while bad, isn’t as bad as President Obama and others have claimed. I still think this is the case, but I would change my mind based on new evidence. However, I think the current situation could end up leading to a really bad situation.
As I’ve noted in my last post and in comments to other posts that currently the U.S. relies to a considerable extent on foreigners to buy U.S. government debt. Further, without these foreign buyers of U.S. government debt the U.S. would likely have to offer its debt at a higher interest rate.
At the same time the current recession will likely result in a budget deficit of at least a trillion dollars this year and probably next. Further, we have TARP, the current stimulus plan and a $75 billion dollar proposal to help bailout homeowners sideways on their mortgages and talk of TARP 2.0. All of this could add close to $2.3 trillion dollars to the national debt. Adding on the deficits just due to reduced tax revenues and we are looking at $4.3 trillion dollars, at least. Currently the national debt is around $10 trillion. So in a few years we could be looking at a national debt of $14 trillion dollars. 
In addition as I have mentioned several times Medicare and Social Security are in actuarial imbalance to the tune of at least $40 trillion dollars. Further, the problem with Social Security and Medicare are not that far off.
All of this combined could make foreign buyers of U.S. government debt very cautious of buying even more. The U.S. could have to offer such debt at a higher interest rate. The effects of this would be to reduce potential economic growth for the foreseeable future. The higher interest rates would likely mean less investment in productive private endeavors reducing growth. Further, since we’d have a harder time borrowing the government might resort to increasing taxes simply to pay for some of this spending. And to make matters worse even higher taxes might be needed to try and address the magnitude of the national debt. All of these things would mean slower growth.
The only hope is that Obama and his supporters are absolutely right. That the stimulus package will have a significant multiplier effect that will offset to a significant degree the increased debt the country is taking on. I, personally, am skeptical of this. For decades economists felt that Keynesian stimulus spending would either be too late or not produce the multiplier theory often predicted. But now all that no longer holds. They trot out new theoretical arguments, but in the end it is still a gamble with no measures to address the country’s precarious fiscal situation. Instead we get insulting commentary by economic-know-nothings like Matthew Yglesias who calls those who disagree with him insane. We even get the same thing from those who do know about economics such as Brad DeLong. Instead of explaining why these worries are not significant instead those of us who hold these views are called idiots, fools, and so forth.
Could things get much worse? Yes, President Obama could be wrong. And if he is wrong things wont get better for a very long time. It is a rather sizable gamble the President is taking with not even token measures to address the fiscal imbalances that are threatening to spin wildly out of control.
Photo by Flickr user MotherPie under Creative Commons license.
 I don’t know of the current $10 trillion includes and of the TARP money.