This morning, I have been meditating on two graphs. The first, above, is from the most recent US Congressional Budget Office Budget and Economic Outlook and shows the CBO's projection for "Federal Debt Held by the Public" as of Jan 2010. It's important to understand that this does not include federal debt held by the social security trust fund and similar, and so future deficits in that trust fund will show up as increases in the federal debt held by the public.
The most obvious features of the graph are the run-up in debt during the Reagan-Bush years (aided by several oil shocks), the decline during the Clinton years (assisted by a massive Internet bubble), the more modest increase under Bush-II, and then the massive shock caused by the financial crisis - federal debt will, the CBO thinks, increase by about 35% of GDP, and then stabilize. Ie, the government rescue of the financial system, etc, will roughly double the size of the federal debt.
I take the CBO to be a technocratically competent organization and reasonably non-partisan, and so I assume that reasonably forseeable things (like increases in payouts for social security and medicare) are accounted for here. Indeed we see tables like this, with the details of those particular issues:
Indeed those things will increase a lot over the next ten years as more of the baby-boom retires.
Still, on the face of it, a federal debt stabilized at about 70% of GDP does not strike me as a definitely fatal condition. If things continue in an orderly manner, and in particular assuming long term interest rates on US treasuries are modest, this seems like a quite manageable debt burden. If we suppose that the federal government can borrow at 4%, then it needs about 3% of GDP to service the debt - not without political consequences, certainly, but hardly likely to be a threat to the republic. This, I assume, is why treasury interest rates are quite reasonable at present. There is no identifiable, forseeable problem which would cause the US to have trouble servicing its debt.
I think where the problem comes, rather, is that it's much less clear that the US can absorb another shock of this magnitude without running into fairly serious trouble. In particular, it's instructive to go back and look at the 2006 Budget and Economic Outlook and look at the exact same Figure 1.2:
This adds two interesting things to the mix. Firstly, we see that the 35% shock to federal debt levels that we now project in 2010 was entirely unforeseen in Jan 2006. This was pretty close to the peak of the housing bubble, and we see that even the CBO's technocrats were completely unaware of the scale of the problem.
Also, this second graph goes back far enough that we can see the WWII shock - in which federal debt increased by almost 70% of GDP. So, considered as a shock to the federal budget, the recent economic crisis was about half the size of WWII, which is an impressively large shock to be completely unforeseen by mainstream society.
Of course, the WWII debt was paid off pretty rapidly in the following decades. However, it seems to me unwise to take that as a precedent: the circumstances were fairly unique. The US was a major oil exporter with most of its oil production ahead of it, and the world's manufacturer - its economic competitors were in ruins from the war. Thus GDP growth and the trade surplus were both very high in the 1950s and 1960s, and paying off the large debt was quite doable. A United States with an aging population and the need to import large quantities of oil and manufactured goods from overseas is a quite different proposition - a repeat of the post-war suburban boom seems very unlikely. Our biggest growth industry in the next decade or two may be nursing homes.
And so, if we were, for one reason or another in a dangerous world, to experience another shock of 30%+ magnitude of GDP, it seems to me we'd be in trouble. Above some level, there is the potential for a vicious circle (as recently happened to Greece) as investors demand higher interest rates to loan, thus making the debt even harder to service, thus causing investors to insist on even more reward for the risk of lending. Clearly, this can happen with domestic debt as well as debt in foreign currencies. At the end of the day, since it's a fiat currency, the central bank can always inflate it away - but that's just a more gradual and polite way of defaulting (and no better from the standpoint of the debt owners).
So I guess I come down here: rescuing the financial system was necessary (though I think the terms on which it was done were far too generous to the private sector, and quite reckless of the taxpayer's interest). However, I don't think it would be terribly prudent to increase the public debt much further than is presently projected if we can help it.