US budget deficit at $1.4 trillion. So What?

It was recently reported that the US Government spent a record $1.4 trillion more than it collected in the fiscal year ended Sep 30. The deficit for fiscal 2008 was $459 Billion. More than 3 fold jump from 2008 to 2009. 

So what caused such big jump in deficit? Bank bail-outs (Freddie Mac, Fannie May), stimulus spending and declining tax revenues due to a deep recession led the government to post such huge deficit.

The accumulated US debt stands around $11.5 trillion which account for about 82% of the US $14 trillion economy. It is projected that the debt will hit a whopping $17.2 trillion by 2019. This figure is the largest in the world in absolute terms but as a percentage of GDP it is less than Japan's $9 Billion debt (189% of Japan's $5 trillion economy) which is the highest in the world in terms of debt to GDP ratio.

Who holds majority of the US debt? Much of the debt is in foreign hands. Interestingly China holds the most - The latest US department of treasury data reports that China holds $797 Billion in US treasury debt. Overall China holds an estimated $1.2 trillion worth of US dollar assets. No wonder Obama calls US-China ties most important of the century. Japan closely follows China by holding $731 Billion of US Debt. The United Kingdom holds about $225 Billion.

Should US worry about the steep rise in deficit? 10-year deficit projections already have raised alarms among big investors such as the Chinese. If those investors started dumping their holdings, or even buying fewer U.S. Treasurys, the dollar's value could drop. The government would have to start paying higher interest rates to try to attract investors and bolster the dollar.

A lower dollar would cause prices of imported goods to rise. Inflation would surge. And higher interest rates would force consumers and companies to pay more to borrow to buy a house or a car or expand their business.

On the brighter side, the US government’s interest payments on its debt actually decreased 23 per cent to $199bn thanks to lower interest rates.

So what does $1.4 trillion represent? It is more than the entire economy of India ($1.2 trillion).

Rajesh Kumar