12/02/2010 04:51 pm ET | Updated May 25, 2011

Deficit Fears May Bring Short-Term Pain

Sample the rhetoric spewing out of Washington and saturating the media and you could come away with the idea that the United States is about to spend its very last dollar. Soon, it seems, the Treasury will be overturning sofa cushions in pursuit of stray change before hocking off the rest of the furniture to the People's Bank of China.

The federal budget deficit must be slashed. On this point, general consensus reigns, even as fierce disagreements play out over how to bring this about. The national credit card must be pried loose from our cheap money-addicted fingers, lest we borrow more and add to our debts and risk -- well, what?

A lot of really awful things, say the fear-mongers who control the conversation. The foreign creditors who hold trillions of dollars worth of American debt will eventually get skittish and demand higher interest rates, and that will suffocate the economy. The value of the dollar will plunge. Crippling inflation will result.

"Our debt comes as a threat to not just our way of life, but our national survival," Republican Senators Tom Coburn and Mike Crapo said in a joint statement on Thursday, as they added their names to the recommendations of a bipartisan panel appointed by President Obama to come up with ways to close the federal debt.

The trouble is, the societal remedy the public is being asked to ingest to avert these long-term, theoretical disasters comes with an immediate and palpable side-effect: continuing indefinitely the epidemic of joblessness, foreclosure and weak economic opportunity in a country still battered by the Great Recession.

The dire scenarios laid out by the deficit hawks who dominate the conversation (not to mention the White House and Capitol Hill) include, at the outer extremes, a Greek-style descent into the unsustainable debt spiral, with the specter of a national default. This is almost unimaginable for the simple reason that the United States happens to print the money that dominates global commerce, supplying the Treasury unsurpassed powers to avoid such a meltdown by issuing fresh dollars.

But accept the possibility of such a scenario, if you will. It cannot be dismissed altogether. Somewhere between here and infinity is a place where the Treasury could print so many dollars that it destroyed faith in the sanctity of our money; a point where foreigners would no longer be willing to send us intrinsically useful things like barrels of oil and containers full of laptop computers in exchange for green pieces of paper bearing the images of deceased American presidents.

But where is that point, exactly? Nobody knows. More important, there is no rational reason to fear we are getting dangerously close to it. China, Saudi Arabia, Japan and the other foreign creditors lending the Treasury money are codependent enablers of American borrowing. They cannot afford to demand repayment or higher interest rates without spooking the markets and sinking the value of the very dollar they hold in such great abundance.

Despite the strident warnings from both parties about the extent of our debts, there is no sign that creditors are reluctant to invest more deeply in the United States and our dollar. The Treasury is now paying close to nothing in the way of interest on sales of its savings bonds, and the world is jamming the gates at each opportunity to buy, for the simple reason that the United States seems as safe a place as any to park savings.

The doomsday scenario driving national policy toward an ill-timed dose of austerity is premised on a crisis that exists in potential alone. Whenever it may be scheduled, it is not happening today.

What is happening now is the dismantling of American communities and institutions just as vulnerable people are in greatest need, a backwards march of history that will only be exacerbated by taking more money out of the weak economy via budget cuts.

In Newark, they are talking about the deficit, but not the one taking up political bandwidth at the national level: They are suffering a shortage of cops on the beat. This week, the city laid off 163 police officers -- about 13 percent of the force -- as it grappled with the declining tax revenues assailing New Jersey and seemingly every other state in the union. This, in a city that has made admirable progress in diminishing crime that (fairly or otherwise) has made Newark a synonym for urban violence.

The impacts of that change do not require an academic exploration into the history of global capital flows, the proclivities of bond traders in Singapore or the merits of esoteric rules named after obscure economists. It can be felt on the street, where people who seek a greater sense of safety instead grapple with fear.

America is the land of alternate deficits that are sure to be exacerbated by budget-cutting. Consider the deficit in retirement funds whose values have been shredded by the chaos in the markets. Major financial institutions effectively had their balance sheets repaired by the taxpayer. Not working people, who will one day need to live off their 401(k) retirement savings plans.

Three of four holders of 401(k) retirement accounts are now sitting on inadequate balances or setting aside too little money to retire with even 70 percent of their income in their working years, according to a recent survey by Financial Engines National 401(k) Evaluation, an independent advisor on such programs. And 39 percent were not saving enough in 2009 to gain their full employer-paid matching contribution, up from 33 percent the year earlier.

In a provocative paper unveiled at a Roosevelt Institute conference held in New York on Thursday morning, Robert Johnson, a former chief economist of the Senate Banking Committee, and Thomas Ferguson, a political scientist at the University of Massachusetts, Boston take aim at the consensus that the national debt amounts to the primary problem of the day. They argue that the downside risks of embracing austerity as economic cure-all vastly outweigh whatever long-term risks are posed by the current trajectory of public debt.

They train their sights on a contention that has gained currency among serious economists -- that once a country's public debts reach 90 percent of its annual economic output, the pace of economic expansion falls off substantially. The 90 percent line has taken on the aura of a boundary between solvency and calamity.

The supposed dangers of the American predicament were underscored by a Congressional Budget Office analysis of President Obama's budget, put forth in March, which projected the national debt level reaching 90 percent of national output in 2020. More than one analyst has used that projection to argue that, in effect, Americans are racing toward the same cliff approached by Greece and Ireland. To which Johnson and Ferguson say: ridiculous.

"For a country in the situation of the U.S., default in a strict sense simply cannot happen," their paper asserts. "No matter what the Chinese or anyone else does with their dollars, the U.S. cannot run out of them."

Their paper argues that the best way to shrink deficits over the long-term is for the government to borrow more now and invest the money in job creating undertakings such as building infrastructure -- in essence, tolerating larger short-term deficits for a stronger economy down the road.

To the deficit hawks, that sounds like dangerous foolishness, akin to buying a lottery ticket to try to get out of arrears. Only a fool -- or a Wall Street trader peddling bogus mortgage-linked securities -- would argue that debt can simply be piled atop new debt forever while the reckoning is magically kept in abeyance.

But we are behaving now as if a very real wolf is at the door in the form of the inchoate danger known as the national debt, when the real wolf is already inside the house gobbling up dinner. We are embracing austerity in the face of an economic dynamic that requires the opposite: aggressive and targeted government investment aimed at spurring new industries that can generate solid paychecks.

"The austerity agenda reminds me of medieval bloodletting," said the Nobel laureate economist, Joseph Stiglitz. "We believe that if we only bleed the patient, they'll get better."

The streets of most American communities are full of work needing to be done and people needing work. That argues for a large-scale infrastructure buildout, as we employ laid-off hands by fixing roads and schools and airports; by constructing the advanced electrical grid required to realize the benefits of renewable energy; by erecting new laboratories that can harness American innovation in a way other than engineering collateralized debt obligations on Wall Street.

But none of this can happen unless we stop acting like the world has a gun to our head in the form of our burgeoning debts.

We are the ones with the gun, and it is pointed at ourselves.