Debt leaves no wiggle room for disasters

NEW YORK (CNNMoney) -- Earthquakes. Tsunamis. Nuclear crises. Disasters are one reason why Washington should get the government's long-term debt under control.

The argument is straightforward, but not often discussed: Already high levels of debt leave the economy even more vulnerable in the wake of unexpected natural and man-made disasters.

"The U.S. has little or no budget to deal with unexpected catastrophic events," said David Walker, the former U.S. comptroller general and now head of the Comeback America Initiative. "Whatever has to be done is done, but it adds to our existing debt problems."

Indeed, the United States traditionally has not had trouble borrowing to help fund disaster relief, said veteran budget expert Stan Collender, who founded the blog Capital Gains and Games.

"The classic example was [President Bush's] response to Katrina when he channeled Lyndon Johnson and said he was going to spend whatever it takes to fix the problem."

In the wake of the catastrophe in Japan, it is likely rates on U.S. Treasurys -- the typical safe-haven investment in times of world crises -- could remain low for awhile.

But while disaster funding is essential, it could also accelerate the journey to a fiscal crisis, which deficits hawks predict will occur at some point if Congress doesn't do anything to reduce the growth in U.S. debt.

Left unchecked, by 2020, 92 cents of every federal tax dollar will be needed just to pay for Medicare, Medicaid, Social Security and interest on the debt.

Broadly speaking, the United States could really be in the soup when interest rates start to rise from the near-historic lows the country has enjoyed in the past few years. And when will rates rise?

First, when the world economy fully recovers because the private-sector will be competing with Uncle Sam for investors' money.

Second, Walker said, "when the market loses confidence in the willingness -- not the ability -- of elected officials to make tough choices."

And since disasters are unpredictable, there's no telling the market's mood in advance.

A disaster destroys a country's assets, making it worth less relative to its liabilities, and that could make the country a less creditworthy borrower in investors' eyes, said Douglas Holtz-Eakin, a former Congressional Budget Office director who now runs a Republican think tank.

That, in turn, could push interest rates higher.

At that point, lawmakers may decide they can't afford to fund disaster relief simply out of borrowed funds given the country's already large borrowing needs. So they might opt for spending cuts and tax increases to cover some of the cost.

But if those changes prove to be too draconian, that could hurt economic growth and tamp down tax receipts, which in turn could increase the government's need to borrow.

Whatever the catalyst, Walker said, rates will rise at some point, whether modestly or drastically. "Under optimistic assumptions, [the debt situation] ugly. Under realistic assumptions, it's horrific."

Markets are looking for some reassurance that the country has a credible plan to reduce U.S. debt over the long run, even if the measures in the plan wouldn't go into effect right away. Until lawmakers produce such a plan, or at least provide a series of stringent budget controls while they work on a plan, Walker said, "we're playing a dangerous game."