The economic landscape still looks pretty gloomy despite (because of?) massive increases in federal government spending by Congress. Want something else to worry about? What if your government suddenly went “belly up” on some or all of its public debt IOU’s?

Impossible you say? Not really.

When individuals or businesses have long-run expenses that exceed anticipated income—and have neither capital nor savings to fill in the gap—they often declare bankruptcy. And though it is rare, even some city governments (i.e., Vallejo, Calif.) have been plunged recently into insolvency and bankruptcy, and some state governments (with heavy pension costs) might consider it. But could it happen to our own federal government?

Most economists have always regarded this possibility as nearly unthinkable. After all, the U.S. government has never defaulted on a penny of its debt obligations in over 220 years. What this means is that when the Treasury sold government bonds, the bondholders have always received their interest payment and have always had their original principal returned at maturity. In that sense, U.S. government bonds have been 100 percent safe.

There are several ways that U.S. debt could become risky and unsafe and increase the likelihood of a general or partial default. The most obvious problem would be that Congress becomes unwilling or unable to raise taxes sufficient to pay, by law, the interest on the national debt.

So far this has not been an insurmountable problem despite the fact that in FY 2009, the interest cost to “carry” the U.S. public debt was $383 billion. (For a frame of reference, the budget for NASA last year was $19 billion.) The carrying costs by year 2019 are estimated to be more than $700 billion.

But these historical costs and projections are based on conservative guesses about deficits and interest rates. What if annual deficits now become trillion dollar holes (as they have) and rising interest rates (as are likely) force governments to pay far more to fund their increasing debt?

The analogy here would be to a credit card holder who already has debt, spends more this month than last, accumulating even more debt and, in addition, faces increasing payments every month because of higher interest rates. It becomes an impossible situation.

In the case of ever-increasing public debt, where does the new money come from to “carry” this increasing burden? Federal taxes would have to be increased to extraordinary levels; but this effort would prove self-defeating since it would likely destroy incentives and the economy to boot.

Another possible debt/default scenario, and just as depressing, is that the Federal Reserve continues to purchase more and more U.S. government debt. When the Fed purchases government securities in the “open market” it tends to push bond prices up and interest rates down, making it easier for the Treasury to market new debt and keep its funding costs low.

Unfortunately, the purchase of government securities (public debt) by the Fed leads to what economists call a “monetization” of that debt. Sellers of the securities get “new money” from the Fed and that new money normally works its way into the economy and raises prices for almost everything including interest rates.

The resulting inflation (or even the anticipation of it) also starts a vicious cycle of dollar depreciation that makes it even harder (at existing interest rates) to sell U.S. debt abroad. Again, as rates increase on more and more debt, the interest and refunding burden grows exponentially, and the once unthinkable becomes at least debatable.

Depressing as it is, however, the U.S. currency and debt/funding situation is actually in reasonable shape (as measured, say, by recent credit-default swap spreads) at least when compared to near basket-case countries such as Ireland, Spain, Portugal, and especially Greece.

A particularly dangerous example is Japan, where government debt is currently an astounding 200% of its GDP and is expected to rise to 230% by 2012. But none of this should make U.S. government bondholders at all smug since defaults on “sovereign debt” abroad could start a contagion that could swamp all boats. Stay tuned.