Bill Gross of PIMCO recently wrote a <a href="http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2004/IO_02_04.htm">commentary</a> on the rising amount
of public and private debt in the US. He argues that the US's total debt 
cannot keep increasing as a percentage of GDP, and that Very Bad Things will
occur when it stops increasing. 

<p>
To take Arjun's example, say lots of Chinese feel that China is a better
place to invest. This will cause the following chain of events, <i>ceteris
paribus</i>:
<ol>
<li>Demand for US assets falls, so there is less investment in the US.
<li>Demand for dollars falls, so the dollar weakens.
</ol>

We know that:
<pre>
 GDP = C + I + G + NX
 
  C  = Consumption (people and corporations)
  I  = Investment
  G  = Government Expenditures
  NX = Net Exports (Exports - Imports)
</pre>

If the dollar weakens, NX will improve. On the other hand, I will fall due to 
less overall investment. So I will have to fall by more than the gain in NX. 
But we know that if China refuses to take dollars, China will insist on 
imports equaling exports, so it can trade as much as possible without taking
dollars. 

<P>
If this is the case, the loss in I from China pulling out will equal the gain
in NX, as we just erased the trade deficit between China and the US (the 
Chinese surplus of which was invested back into the US). 

<p>
Now, we need to think about what happened to the interest rate. Since less 
people are demanding US bonds, the rates for these have increased. This will
force up interest rates in general in the US. This will cause Investment 
to fall, as a bunch of projects that were profitable just got edged out by
the higher interest rate. This means C falls, causing GDP to fall overall.

<p>
Now we get to the crux of Gross's argument. 
The US uses increasing amounts of debt to move its GDP forward. If access to 
debt is restricted, the economy might be leveraged into reverse. 

<p>
If GDP is falling because I is falling, consumers will be more apt to save, so 
C will fall also. In the past, this downward spiral was countered by increases
in G, governmental spending (Classic Keynesian). But if the government already
has a bunch of debt outstanding, attempts to sell more bonds will only 
increase the general interest rate level. And this would be a Very Bad Thing,
as the bulwark of last resort (the US Government) was hindered by its current
debt.

<p>
Gross essentially shows why deficits are bad unless they are truly needed, but
his argumentation is extremely elliptical. The private sector can get crazy
with loans, that's bound to happen, but the Government must be able to supply
the spending when the private sector loses it.

<p>