The U.S. debt crisis...the next great depression?

Disclaimer: Just posting this as some food for thought and opportunity for interesting debate. It's got nothing to do with the regular stuff discussed on WSO so stop reading here if that's what you were looking for!

We all see the drama over the debt ceiling go down this month. It's great that we kicked the can down the road, but my question is - why are not more worried about our sovereign debt? I think we can all pretty much agree that a debt default would be catastrophic. There would be a recession the likes of which we have never seen. I think we can also agree that the debt problem is quickly becoming intractable. By now, almost all of us must have seen in the news what the astronomical numbers on our debt are, and how they stack up against our fiscal inflows and outlays. The math pretty much doesn't work.

So here am I asking all my fellow monkeys on WSO and in the finance community at large....why are we not more worried? Investment banks, private equity shops, money market funds and hedge funds will probably be the first to fall if the U.S. defaults. And as someone who has planned a long term career in finance, I ll admit that this has me pretty worried...

But it doesn't seem like the finance community cares about this too much. Can someone explain to me why that is? I am still in college so I may be missing lots of things in my analysis. But the way I understand it, here's roughly what's been happening:

1. Fed is keeping interest rates low by buying government debt, which in turn is done by 'expanding the monetary base'. As far as I can tell, that pretty much means creating money out of thin air at the rate of $85 billion dollars a month. It's simply a transaction where the Fed debits the assets side of their balance sheet by $85 billion, and credits the corresponding account of the commercial/investment bank they bought the bond from an equivalent amount. That money is created from nothing. A virtual printing press if you will. And it multiplies throughout the country via our wonderful Fractional Banking Reserve system.
2. The debt has now hit $16 trillion (debt/GDP is 120% I think). On top of that interest rates can't stay low forever...they will have to rise. Which means that in addition to a gargantuan principal, interest payments on Treasuries will also soon become unaffordable.
3. As far as I can tell, so far we have skated by for two reasons. One, the dollar is the world's reserve currency. Two, U.S. Treasuries are considered to be the safest investment asset in the world. As long as these two axioms hold, people are always happy to lend us more. And we are always happy to borrow more to pay them back. We have been doing this successfully for the past eighty years, having raised the debt ceiling a total of 78 times since then, and having defaulted just once (in 1979).

OK great, clearly this formula has worked. But how much longer can this sustain itself? No other country has been able to borrow its way out of trouble in the history of the world. It seems that everything hinges upon our ability to hold on to our status as the world's biggest wheel. As long as we are the dominant superpower, hunger for dollars and Treasuries will continue, and we be able to either borrow or print our way (without raising inflation too much) out of this mess. But what happens if eventually people start losing faith in the dollar? The bottom falls out of the whole thing. Investor's don't want the $ anymore. Foreign governments (who hold reserves in $) don't want it. Commodities like oil or gold, which have always been denominated in $ suddenly see sharp increase in price as the currency falls. In such a scenario, it is almost impossible to see how we can NOT default.

I don't know when this will happen. Certainly not next year. But maybe 5 years? 10 years? It all depends on when something comes around that will replace the U.S. as the next superpower, and the dollar as the new reserve currency (maybe the yuan? or a basket of currencies???). But it doesn't seem impossible. At least not after 2008.

I am probably being overly pessimistic and alarmist (Bernanke has probably heard the above arguments a zillion times). But I still think there is some truth in it. What do you think? Let it rip below!