Past debt constricts government's economic maneuvering room

WASHINGTON — The idea that the government of a major advanced country would default on its debt — that is, tell lenders that it won't repay them all they're owed — was, until recently, a preposterous proposition.

Argentina and Russia have stiffed their creditors, but surely the likes of the United States, Japan or Great Britain wouldn't. Well, it's still a very, very long shot, but it's no longer entirely unimaginable. Governments of rich countries are borrowing so much that it's conceivable that one day, the twin assumptions underlying their burgeoning debt (that lenders will continue to lend and that governments will continue to pay) might collapse.

What happens then?

The question is so unfamiliar that the past provides few clues to the future. Psychology is crucial. To take a parallel example: the dollar. The fear is that foreigners (and Americans, too) lose confidence in its value and dump it for yen, euros, gold or oil. If too many investors do that, a self-fulfilling stampede could trigger sell-offs in U.S. stocks and bonds.

People have predicted such a crisis for decades. It hasn't happened yet. The currency's decline has been orderly, because the dollar retains a bedrock confidence based on America's political stability, openness, wealth and low inflation. But something could shatter that confidence — tomorrow or 10 years from tomorrow.

The same logic applies to exploding government debt. We have moved into uncharted territory and are prisoners of psychology. Consider Japan. In 2009, its budget deficit — the gap between spending and taxes — amounts to 10 percent or more of gross domestic product. The total government debt — the borrowing to cover all its deficits — is approaching 200 percent of GDP. That's twice the size of its economy. The mountainous debt reflects years of slow economic growth, many "stimulus" plans, an aging society and the impact of the global recession. By 2019, the debt-to-GDP ratio could hit 300 percent, says a report from JPMorgan Chase.

No one knows how to interpret these numbers. If someone had predicted 20 years ago that Japan's debt would rise so spectacularly, the forecast would doubtlessly have inspired this alarm: Japan will pay crushing interest rates as fearful lenders demand high returns to compensate for the risk that government might default or inflate away its debt. Instead, the opposite has happened. Japanese investors — households, banks, insurers — have absorbed 94 percent of the debt, reports JPMorgan. Interest rates on 10-year Japanese government bonds have dropped from 7.1 percent in 1990 to 1.4 percent now.