TNI December 2010 -- We’ve heard for years that the government’s deficit was too big. They said it of Reagan’s deficit and George W. Bush’s. But no government debt crisis ever came, nor should it have.
This time is different.
Unless the new Congress sharply changes course, by 2012 the total outstanding public debt of the U.S. federal government will reach 100% of Gross Domestic Product (GDP) [See Sidebar: "Debt or Poker Chips
"]. This means that, for every dollar of new goods and services that Americans produce by working for a year, a dollar’s worth of government debt will hang over it.
That debt must be repaid, sooner or later, squeezing out all the other private borrowing, saving, investing, and spending that we need to engage in if we are to thrive, and taking away government funds from current projects. In fact, about 15% of that debt is money raided from Social Security payroll taxes to pay for general expenditures: Social Security couldn’t keep its promises in the future even if it had
Is the U.S. too big to fail?
One hundred percent of GDP is a level of debt that has crushed other countries. It’s a level the U.S. only reached once before, briefly during World War II. After that war, the government shrunk the armed forces and so axed the related costs. But today, the administration predicts the debt will stay high for years to come. And given the outlook for spending on new entitlements like Obamacare, no axing of anything major looks likely.
Are these the last throes of a spendthrift culture before a long fall to poverty and mediocrity begins?
A Run on the Treasury
In the financial crisis of 2008, the U.S. government acted as the creditor of last resort. It borrowed hundreds of billions of dollars on the open market from panicking investors, and it used the money, via the “TARP” funds, to stabilize bankrupt businesses and thereby stanch the bleeding in the banking system. At that time, government debt amounted to around 65% of GDP. Now imagine the same scenario, but at today’s debt levels.
Wait, you don’t have to imagine it! Greece showed us how it goes. In the spring of 2010, as Greek government debt soared beyond 100% of GDP, interest rates spiked over 10% per year. The easy money of a few years ago had evaporated. Today, the Greek economy, which is much poorer than the U.S., per person, is shrinking
by 3% every year. Unemployment is nearly 12%. The government is slashing spending just to get the annual deficit below 8% of GDP per year.
A blind, lurching pragmatism is the order of the day.
A similar scene just played out in Ireland. The Irish government weathered the 2008 crisis pretty well thanks to having amazing low government debt at the start of the debacle. But their decision to back the many wobbly Irish banks caused the government to borrow heroic sums of money, with projected deficits passing 30% of GDP. For over a year, all looked well, but Ireland hit a wall in October. Investors ran for the exits, buying gold and other currencies, and hanging onto cash rather than lending to the government. The Euro economy as a whole shivered. The interest on Irish government debt more than doubled in a few months.
Greece and Ireland are small countries. The E.U., led by the Germans, grumbled, imposed conditions, and then saved both countries from the worst. Still, Ireland’s share of world borrowing just isn’t that big. The U.S., however, is big, very big. It’s by far the biggest country, economically. Might the U.S. be too big to fail? Actually, it’s just the other way around: the U.S. plays such a central role internationally that if it fails no one else can save it. Currently, foreign investors come to the U.S. voluntarily because it is stable and creative. U.S. government credit has been reliable for generations. But as any investor knows, past performance is no guarantee of future results.
Here’s how it could end: there’s a crisis somewhere. Perhaps Japanese savings fall too far. Or California, in a final spasm of governmental incompetence, defaults on its debts. Or maybe the German economy falls into decline, or the Chinese one does. Or a new Russian war cuts off Europe from natural gas, causing a massive recession. Or maybe it just starts with a rumor on Wall Street that the latest U.S. bond issue is a bridge too far. It doesn’t matter—suddenly, the dollar is falling. Why the dollar? Because suddenly not enough foreign savings are washing up in U.S. capital markets: the money stayed home instead. Or the dollar is tanking because bad U.S. news tips market sentiment pessimistic on government debt, and foreigners head for commodities and other currencies.
Yearly deficits are a ritual in practically every legislature and state house.
U.S. interest rates jump higher and higher. Oil prices skyrocket: a falling dollar means more dollars must pay for foreign oil. Businesses fail, trade declines, and deals don’t get made. In Washington, the powers that be realize something must be done: they raise taxes. The government employee unions, the senior citizens, and the other regulation-dependent interest groups dig in their heels. They’ve been the first to feed at the government trough and will be the last to leave it. Unemployment below 10% is now a distant memory. Bridges fall down and highways fall apart. As banks fail (again and again) the federal government can’t step in: it can’t raise the cash any more. The Federal Reserve will help out, pushing more dollars into the system. Rampant inflation is the result. It’s the return of the 70s with a vengeance: stagflation with no growth in sight. The U.S. is now the Argentina of North America, with swelling poverty and ever-greater battles in Washington over the ever-shrinking pot of loot. It’s a scene out of Atlas Shrugged
This story ends in either inflation or taxes. The government could avoid a monetary collapse, but only at the price of raising taxes to twice today’s level. Perhaps the “solution” will be a rise in the social security payroll tax to 10%, plus a new 20% value-added tax on sales. Either way, the longer term outlook for the U.S. would be permanently changed, even if price inflation is avoided. Once the dynamo of the world economy, the U.S. would now stagnate, entering decades of little or no growth like those Japan has been suffering through since the 1980s bubble popped there. Once a proudly mobile society where class didn’t really matter, the U.S. would now be sharply and formally divided between the connected, legally-privileged “haves” and the “have-not” remainder who would foot the bill and bear the burdens in a crumbling economy.
A Nation of Deficit Spenders
There’s nothing wrong with debt. In fact, without debt, we’d be far poorer and more miserable. Borrowing money for productive uses allows people to create new wealth and pay interest to lenders. Capitalism and economic growth couldn’t happen without it. We need borrowing to be able to provide insurance and grease the workings of world markets for goods and services. We also need borrowing to smooth out patterns in life-cycle earnings: borrow to buy a house or get an education when you are young, save for retirement as you age.
But the U.S. has followed a generation-long slide into a deficit culture of constant borrowing. Visible yearly deficits are a ritual in practically every legislature and state house where they are allowed. Off-the-books deficits are the norm where formal deficits are forbidden by law. Governments also have unfunded liabilities for Social Security, Medicare, and employee pensions that beggar the mind.
The U.S. could become the Argentina of North America.
Most Americans aren’t doing any better as individuals. We borrow for consumption purchases: not just to buy a house, but to splurge on a vacation, to upgrade our car, and to maintain the lifestyle to which we’ve become accustomed. The personal savings rate (the share of savings in total income) fell below 2% in the past decade. Most people spent more on coffee and beer than they saved for future needs! Personal saving has rebounded during the Great Recession to over 5%, but that is still paltry considering that the government alone is borrowing at a clip of over 9% of GDP per year. Furthermore, the Baby Boom generation is realizing that it needs retirement funds. The boomers are now at their lifetime earnings peak: their savings should be prodigious. But, in fact, they’re modest. Too many were counting on rising home equity, it seems. Most people aren’t wildly profligate (only a minority carry high, interest-bearing balances on their credit cards, for instance). But too many have taken too long to realize that the future will come and there will be rainy days.
In the country of deficit spending, too many have no real plan for retirement. Too many expect someone else—the government, their employers, or “the rich”—to take care of the big problems. Social Security and Medicare were billed as supplements to help out the indigent elderly. Now too many are likely to depend on those programs, even though the real value of their incomes has been far higher than that of preceding generations. It is foreseeable that one will get old. Yet too many blind themselves to such obvious facts and just live for the present. Hopes and dreams substitute for prudence and planning. Resentment replaces responsibility.
Then there are the bureaucratic types that throng capital cities like the one where I live. They want a nice work niche, engrossing entertainments, and plenty of leisure, without having to take responsibility for making those things happen. They’re used to faceless corporations providing them with goodies in abundance: they’ve never thought to wonder how or why. “The rich” and “business” will pay for everything; it doesn’t have much to do with people like themselves. They want to follow rules that someone else gives them, to enjoy rewards that someone else must organize and prepare. But if their job security comes through taxes, then it in fact is extracted from the ability of others, others who are now broke and who in any case didn’t agree to carry ever-swelling bureaucracies and ballooning entitlements on their backs forever.
The Tipping Point: Chinese Finance
When the government deficit exceeds domestic savings, there is only one place the funds can come from: abroad. Today, our international borrowing runs over 3% of total income per year. About a third of the total government debt is owed overseas. That’s fine: one man’s money is as good as another’s, and people have the right to trade and invest no matter whether they are locals or foreigners.
But the dominant provider of finance to the U.S. today is China. And China’s investments are not simply the result of millions of private decisions, as is normally the case in private markets. Instead, Chinese investments are driven by choices made at the highest levels of Chinese government. The Chinese government is pursuing a mercantilist policy, driving industrial development by keeping its currency cheap and accumulating big foreign exchange surpluses as a result—a huge pool of cash it invests abroad in instruments like U.S. Treasury bills.
There’s a story I tell myself about China. It goes like this: China’s leaders want to emulate Lee Kwan Yew’s long reign over Singapore, guiding their country to first-world riches and their party to an unimpeachable position of power derived from competence. They aren’t Marxists anymore. They are modernizing, soft authoritarians. In 30 years, China’s aging population will put a heavy burden on its financial system. So the Chinese government is accumulating surpluses now with the decades ahead in mind. It needs a thriving U.S. (which will be younger demographically) to fund China’s economy over the long haul and keep the Chinese leaders’ competence unimpeachable. China keeps investing in the U.S. because, despite our problems, no other place else is big enough and dynamic enough to put China’s savings to productive use. They are lending now so they can borrow later.
But different, less optimistic stories could be told. You might well think that the big imbalance in China’s foreign exchange has to end, perhaps soon. The Chinese people are paying for it every day, through reduced consumption and higher prices. Maybe the imbalance only works so long as the U.S. provides rock-solid security in its Treasury bills and unparalleled opportunity in its equity and private debt markets. Maybe now we have grave problems we didn’t have five years ago. Now, as U.S. government debt crosses the frontier of 100% of GDP, it isn’t looking so solid. Now, ever-greater regulation mounts—with moratoriums on drilling, on foreclosing, on insuring—and fast, U.S. style growth is not returning. Maybe it’s time for China’s hundreds of billions of dollars to go somewhere else, to be sold for Euros, Rupees, Reais, or Yen.
Maybe linked collapses of the dollar and the U.S. capital markets are right around the corner. If so, the driving force will be our deficit culture.
Seeing Beyond Our Noses
Too many today count on economic growth, without appreciating where it comes from. Too many want to consume now, without having produced the wherewithal to do it. I’ve heard this described as “me-ism,” but that’s the wrong term. It’s not in one’s self interest to stumble forward into a mess of one’s own creation. But the problem here isn’t self-sacrifice, either. People are not being irresponsible for a cause, or in order to destroy their livelihoods, or for the sake of others.
The cure will require a break from the past.
No, the problem is that too many are, as Ayn Rand
said, “concrete-bound.” Too many focus on the goods they have today rather than the costs those goods imply tomorrow. The politicians shamble from one election to the next handing out goodies to constituents and buying off powerful interest groups like the teachers’ unions, mass transit, and the ethanol lobby. Tea Party activists, our best hope at this time, have been known to rave against big government and
against threats to their Medicare (the biggest government boondoggle of all). Republicans and Democrats cut deals to cut taxes and raise spending. Americans take the wealth and influence of their culture for granted, but don’t care to understand its causes. A blind, lurching pragmatism is the order of the day, as people focused on concretes grope for the policies and plans of action that will bring prosperity back, or at least pay off somehow, and soon!
The cure is simple. But it will require a break from the past.
Politically, we need to insist that the government be put back within its bounds. Such a limited government will, among things, be one that lives within its means and that borrows only in the most extraordinary times. 2008 may have been a time for government to borrow—someone had to. It was a once-in-a-generation financial crisis. But 2005 was not. 2012 will not be a time to borrow, either. And balance cannot come only or mostly through tax increases. The burden of government on civil society must decline if the economy is to flourish. The many state government constitutions that forbid deficit spending, or that set sharp limits on state government deficits, are a model for the national government as well.
The Obama administration has so far mostly talked balanced budgets while it actually runs astoundingly large deficits. But now its deficit panel, the National Commission on Fiscal Responsibility and Reform, has issued its conclusions. The commission’s findings show, really, how far we still have to go. The commission sees the looming debt problem clearly. To address the deficits, it proposes in effect to raise the share of taxes in GDP by a quarter while capping spending (this will cause inflation to erode spending back down to 2006 levels in real terms over several years). The commission didn’t give the spending culture of the past decade a free pass, and it does propose streamlining the tax code to lower marginal tax rates on income. But it thinks the general public should mostly just pay more to cover the profligacy of Bush junior and Obama. Maintaining government spending is apparently the commission’s second highest value behind fiscal balance.
The British Conservative-Liberal coalition government under David Cameron has showed us what really needs to be done. Facing a crisis in finance quite similar to ours—with the low savings, the ballooning total debt, and annual government deficits at 11% of GDP—the new government proposed cutting on the order of 20% out of the total national budget. In the short term, it could put hundreds of thousands of out of work and raise costs for tens of millions. But the Chancellor of the Exchequer argues that this will liberate private funds to restart growth and provide goods more efficiently. The policy is tough medicine, but it is medicine that America needs, too. It’s a treatment that values taxpayers more than bureaucrats and subsidy hogs.
Nevertheless, more important than the politics is the personal change that avoiding collapse will require. For most Americans, especially those in their prime earning years, this change requires saving and investing substantial portions of one’s income. It requires only taking the indulgences in life that one can pay for and being responsible for one’s needs over the long term. Changing personally means taking shorter-lived mortgages, with bigger down payments. It means saving for that new car, not taking on more debt. It means bringing monthly charges under control, so that one knows how much is going out and what benefit one is getting for the expense. And, yes, it means ceasing to view the government as a sugar daddy.
At one time, America was a country that lived for the future. Now, we live for the moment, and we can’t see beyond our noses. But we can do better. We can live up to the ideals of the country by putting into practice the ethic of productiveness and responsibility that long-term prosperity demands. We can be a nation of savers and investors again. We can be capitalists.