"Previous episodes when federal interest payments (as a proportion of total outlays) reached similar levels as today were followed by fiscal consolidation."
Getty Images
Investors shouldn't fear US debt crisis just yet, as the situation is more benign than it appears, PIMCO econmist Peder Beck-Friis wrote on Thursday.
In an op-ed in The Financial Times, Beck-Friis wrote that investors will need to prepare for higher instability before policymakers treat the debt seriously.
"Financial markets are likely to become more sensitive to fiscal and political shocks. Limited fiscal space will probably constrain fiscal policies in future downturns," the economist wrote for the Financial Times. "Coupled with fatigue over quantitative easing programs, this will also add to a more volatile macro outlook."
However, ss of right now, the situation does not pose any immediate threat, he noted.
In the past year, Washington's widening budget deficit has set off alarms among market commentators, including PIMCO's own co-founder Bill Gross. Like many other big-name market observers, he argued that the aggressive rise in the US debt will eventually hit unsustainable levels.
That's the case when interest rates are high, as they boost the borrowing costs the US must pay on its debt. This pushes the government to borrow even more, inducing a debt spiral.
The repercussions of a national default are largely unknown, but some predict that fallout could include surging inflation and an economic slump.
Although Beck-Friis acknowledged the worrying run-up in US debt, he also cited data that should brighten the outlook for the near term.
Growth in the country's net national wealth has eclipsed public borrowing in the past decade, he said. The US also faces fewer fiscal constraints than its global peers and enjoys continued demand for its Treasury debt.
"What does that mean for US debt in coming years? The overall baseline outlook is probably one of status quo: The deficit remains high, debt continues to climb, and demand for US Treasuries stays robust, in part because of the dollar's status as a global reserve currency," Beck-Friis said.
Eventually, the debt will need to be addressed.
Analysts have reiterated that the most obvious response would be to lift taxes and slash spending. To their disapproval, political brinkmanship and large spending plans on both sides of the aisle have dimmed chances of this happening.
Beck-Friis is less concerned about this. Pointing to history, he noted that Washington embraces reform eventually, especially when debt grows amid uncomfortably high inflation and interest rate levels.
"Previous episodes when federal interest payments (as a proportion of total outlays) reached similar levels as today were followed by fiscal consolidation — after the second world war, under Ronald Reagan in the late 1980s and under Bill Clinton in the 1990s," he said.
What's more, the US has the means to respond.
Compared to Europe, the country's tax burden is lower, meaning that Washington has more room to raise taxes. Not only would that provide more revenue, it would grant the US more fiscal credibility, Beck-Friis added.
