As long as China (and any other foreign government) keeps buying our debt, we are just fine and can keep living beyond our means. But at some point economics says that the "piper must be paid."

The federal deficit is the amount each year by which federal outlays in the federal budget exceed federal receipts. But the federal debt increases each year by substantially more than the amount of the deficit each year. That is because a substantial amount of federal borrowing is not counted in the budget, and the yearly deficit adds to the debt. The deficit is NOT the same as the national debt. National debt is completely different. The debt is accumulated deficits. The national debt continues to grow with each additional deficit. If the federal government runs a surplus, the national debt is still there, and will not be reduced unless the surplus is applied to it.

The Congressional Budget Office (CBO), on October 13, 2005, issued a report entitled, "Long-Term Economic Effects of Chronically Large Federal Deficits." Let me tell you, folks, that economics has NOT changed since 2005. The report states, "Persistently large federal deficits can erode the growth of future living standards by reducing national saving, which slows the accumulation of wealth, and degrading economic performance." The report continues, "The degree to which chronically large deficits adversely affect future living standards depends in part on the policies that produce them. Policies that increase the deficit but also provide incentives for people to work, acquire more skills and education, undertake research and development, invest, innovate, or use resources more efficiently may do less harm to future living standards than policies that increase the deficit without providing such incentives."   [emphasis mine]

Therein lies the "rub." President Obama (and Bush, and Clinton, and Bush, and Reagan, and Carter…) may talk a good game, but their policies do/did very little or nothing to hold people accountable for their own actions. The opportunities are/were there, but most people choose/chose not to take advantage of them. The old saying, "You can lead a horse to water but you can't make him drink" comes to mind. But I digress. This post is about the effects of deficits and debt on the economy.

Now let's turn our attention to recent deficits and national debt, both in terms of dollars and in terms of percentage of Gross Domestic Product (GDP). For the years 2009-2012, the deficit was/is/will be $1,413 billion, $1.293 billion, $1,299 billion, and $1,101 billion. As a percentage of GDP, the deficit was/is/will be 10.08%, 8.89%, 8.61%, and 6.96%. This source also has a graphic presentation. The 2009 deficit was a result of the Bush budget. 2010 and 2011 were the results of Obama's budgets. 2012 is a forecast based on the Obama budget.

As of August, 2011, after the government's debt ceiling was lifted, the U.S. debt was $14.58 trillion, surpassed 100 percent of GDP, which was $14.53 trillion. For the years 2009-2012, the debt was/is/will be $11.9 trillion, $13.5 trillion, $15.5 trillion, and $16.7 trillion. For the years 2009-2012, debt held by the public was/is/will be $6.8 trillion, $8.2 trillion, $9.9 trillion, and $10.8 trillion. Debt held by the public includes debt actually held by the public and foreign governments, and debt held by the Federal Reserve System, or monetized as part of the monetary base. As a percentage of GDP, the debt was/is/will be 84.74%, 92.97%, 102.63%, and 105.32%. This source also has a graphic presentation. BTW, the debt as percent of GDP for Greece in 2011 is 158% in 2011, and is projected to be 166% in 2012. BTW2, the US national debt was 51% of GDP in 1988.

As can be seen from these sources, little has been done to curtail deficits or to reduce the national debt.

So, how will sustained deficits affect the US economy? Deficit spending and can stimulate economic activity, especially in a recession. But (and there is always a "but"), in the long run, the resultant debt increase (because of deficit spending) is damaging to the economy because of higher interest rates that result from increased dollars in the economy, and thus causing inflation. Foreign governments and investors will be less willing to buy Treasury bonds because of repayment in inflated dollars. The greatest effect is the debt to Social Security. Dollars will need to found to pay benefits as Baby Boomers retire. To pay retirement benefits, taxes will have to be raised, slowing the economy. Further, loans (see below) from the Social Security Trust Fund will be curtailed, causing more government spending to sustain current living standards. This will provide less stimulation, and further slow the economy.

How will sustained debt affect the US economy? The Social Security trust fund must be (theoretically) paid back as the Baby Boomers retire. Since this money has already been spent on previous retirees and has repeated been raided (by both parties) to prop up general spending, resources need to be identified to repay this loan, meaning higher taxes and/or reduced benefits for future retirees. Further, foreign holders of US debt, such as China, are investing more in their own economies, reducing demand for US T-bill and increasing interest rates, thus slowing the economy. Anticipation of lower demand puts downward pressure on the dollar. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand. Bottom line: debt slows the US economy.

So what does all of this mean? Well, as long as foreign governments will continue to sustain us, nothing. But, as this source says, China, the largest US debt holder, is not pleased with the US, particularly with the Standard & Poor's downgrade of US long-term debt. If China reduces buying Treasury bonds, the dollar would weaken and America's borrowing costs would increase sharply, also hurting Chinas existing holdings. China is calling for international supervision over the issue of US dollars. If China is successful, it will mean loss of sovereignty for the US as other governments can tell us what to do. It also wants a new stable and secured global reserve currency as an option to avert a currency collapse caused by any single country.

As long as China (and any other foreign government) keeps buying our debt, we are just fine and can keep living beyond our means. But at some point economics says that the "piper must be paid." The question now is, "How ugly will the payment be?" Does what is currently happening in Greece and Europe come to mind? But that's just my opinion.