President-elect Barack Obama and the incoming Congress need to quickly pass a huge economic stimulus plan. Since the U.S. Treasury doesn't have the extra $775 billion needed, the money must be borrowed.
So where will the government get the money? To raise the billions of dollars for the stimulus, the federal government will sell bonds.
The sale of U.S. Treasury bonds can easily be explained as a loan to the government. "A bond is simply an IOU issued by the government of business," said Mark Zandi of Moody's Economy.com. "They say you lend me some money today and I'll pay you back in the future and also I'll give you some interest on top of that."
U.S. Treasury bonds are considered to be an extremely safe investment, since everyone believes the U.S. government will repay its debts. With the current state of the economy and other investments looking shaky, a lot of people are interested in buying bonds. In fact, nearly half of the $450 billion worth of bonds issued last year were purchased by foreign countries, including countries with whom we have intermittently tense relationships such as China and Saudi Arabia.
The U.S. government doesn't pay a very high interest rate because of the popularity of the bonds. In order to come up with another $775 billion for Obama's stimulus plan, the government may have to pay an increased interest rate, to make bonds more profitable and attractive to new investors and more competitive against other financial institutions.
But there is risk involved. If the U.S. government raises interest rates on bonds it will have a ripple effect. Interest rates on mortgages, car loans and credit cards will also rise, making them more expensive. That in turn will slow down the economy and could erase the very stimulus the government is trying to create.
Economist Mark Zandi says although this is a necessary risk, we're going to have to deal with the consequences down the line. "Once we get into 2010, 2011 and 2012, the problem is going to quickly switch from let's get the economy going to how are we going to repay the deficits that we're just choking on? So it's going to be the problem in our future," said Zandi.
Most economists agree there is no other choice. Every year that the U.S. spends more than it has, it adds to the overall debt, which keeps growing larger. After bailing out the banks and car companies, fighting two wars and now adding the new stimulus program, the U.S. is building a deficit that will dwarf all the previous years. Economists say as soon as the economy recovers, we will have to pay down our debt, which may mean cutting programs like Social Security and Medicare.