It’s the looming presence of this potentialcrisis that brings Walker to this office every day, Macleans writes, through the doorwaywith the words "Honesty Accountability Reliability" inscribed above, inhopes that someone will listen and take up the challenge before it’stoo late. "The sooner we start fixing this, the better," he says,"because right now the miracle of compounding is working against us.Debt on debt is not good. We have to first stop digging, and thenfigure out how we’re going to fill the hole."
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As of February, the U.S. national debt stoodat US$7.7 trillion. And this year, the country is projecting anotherrecord deficit of US$427 billion, increasing its debt by about US$1.2billion a day. Thanks to low interest rates, the cost of borrowing allthat money remains relatively low, amounting to about 8.6 per cent ofthe federal budget for 2005. But when rates rise, so will the cost ofcarrying that debt, and current White House forecasts suggest that by2010, those yearly costs will hit US$314 billion.
But even thoseprojections don’t adequately capture the depth of America’s financialhole. For one thing, current budget estimates do not include the costsof the ongoing military campaigns in Iraq and Afghanistan, which areexpected to require an additional US$80 billion in funding over thenext year or so. The budget also does not factor in any costsassociated with the President’s plan to reform Social Security, whichwould give people the option of diverting some of their taxcontributions into private retirement accounts they manage themselves.That plan will call for between US$1 trillion and US$2 trillion inadditional government borrowing over the next decade. Bush has proposedcutting the budget deficit in half by 2010, but that strategy doesn’ttake into account his pledges to make permanent many of those temporarytax reductions introduced in 2001 and 2002, not to mention other taxcuts promised but not yet implemented.
What’s more, none of thiseven begins to deal with the most pressing challenge of all: how to payfor the sunset years and medical costs of about 77 million baby boomersgetting set to retire. Walker refers to this as a "demographic tidalwave" coming to swamp the country’s finances. He estimates that whenyou take into account the unfunded liabilities of Social Security,Medicare and Medicaid — programs that together comprise the heart ofthe U.S. social safety net, paying pension and health-care costs forthe elderly, as well as providing medical coverage for the poor –America’s long-term budget shortfall is approximately US$43 trillion,about four times the size of the nation’s economy, and more than 20times the federal government’s annual tax revenues. And some actuariesthink even that number understates the size of the problem.
Tomost observers, it’s becoming increasingly obvious that, within thenext 10 years, the U.S. government will simply not be able to borrowmoney fast enough to keep up with its exploding expenses. That has hugeimplications for everything Americans do, from funding the military toprotecting the environment. The Economic Policy Institute recentlyprojected that under the current tax regime, by 2014 all governmentrevenue would be consumed by four areas of spending: health care forthe elderly and the poor, Social Security for retirees, nationaldefence and interest on the debt. There will be no money left for suchfundamental initiatives as education, transportation or justice, whichmeans the government would be forced into ever-escalating borrowing topay for basic programs. Walker’s department projects that, under thecurrent tax rates, interest costs on the skyrocketing national debtwould be about half of all government tax revenues by 2031. Ten yearslater, the cost of servicing the debt will exceed all governmentrevenues.
Laurence Kotlikoff described this burgeoning crisisfour years ago in a paper entitled "The Coming Generational Storm."Last year, he provided a dark summary of the situation in a Fortunemagazine article. "The U.S. government is effectively bankrupt," hewrote. The available options to close the fiscal gap? Hike income taxesby 78 per cent; slash Social Security and Medicare benefits by morethan half; or eliminate all other discretionary spending. "That," heconcludes, "is America’s menu of pain."
TheUnited States is the world’s best customer. It buys far more fromforeign countries than it sells to them, resulting in a sizable tradedeficit. It also spends more on public programs than it collects in taxrevenues. And to pay for all these outlays, the U.S. must attractmountains of foreign capital each year, which essentially amounts toborrowing from foreign governments and investors. This is commonlyreferred to as the current accounts deficit — which was running atUS$665 billion last year.
Those foreign countries don’t lend outof the goodness of their hearts; for the most part they lend becausethe U.S. uses that money to buy goods from them and other nations. Inmany ways, the prosperity of the developed world, including Canada,Europe and parts of Asia, has been financed over several decades byAmerica’s rampant spending, says David Rosenberg, a Canadian who ischief North American economist for Merrill Lynch in New York. InCanada’s case, by year-end this country had sold $8.8 billion more ingoods to the U.S. than we bought from it — despite the loonie’s sharprise against the greenback that made Canadian exports less affordableto Americans.
But foreign investors cannot go on foreversupporting U.S. spending. A banker who holds your mortgage and car loanwill get nervous if you keep coming back to up the limit on your creditcards, and international debt markets work in much the same way. Thequestion becomes, how much longer will those investors be willing tolend to the U.S., especially at the current low interest rates, whenthe country appears to have no plan for meeting its long-term fundingneeds? The issue is even more pressing given the fact that the U.S.dollar has been falling for more than a year, decimating returns forthose foreigners who invest in U.S. bonds.
Stephen Roach, chiefeconomist at Morgan Stanley, is an outspoken critic of U.S. fiscalpolicy and has long warned that America’s increasing reliance onforeign lending puts it at risk of a major economic shock. A suddendrop in the dollar could trigger, among other things, a stock marketcrash, a plunge in the real estate market, a deep recession, or all ofthe above. "There’s nothing stable about America’s dependence on thekindness of strangers," Roach wrote in a report last summer. "Thefunding of America is an accident waiting to happen."
At a recentmeeting with fund managers in Boston, Roach said he believes there is a90 per cent chance the country’s rampant borrowing will eventually leadto a disaster for the economy. Others, including former U.S. treasurysecretary Lawrence Summers and former president Bill Clinton, use lessinflammatory language but have also warned that the size of U.S.deficits could compromise the nation’s foreign policy and trade andsecurity goals. For example, how long can Washington stick to itscommitment to defend Taiwan against Chinese aggression when it borrowsso heavily from China to support the American economy?
DavidRosenberg scoffs at alarmists like Roach, but he does acknowledge thecurrent fiscal path is unsustainable. He quotes economist HerbertStein’s old maxim: "Anything that cannot go on forever, will stop."
Historyprovides some harrowing examples of what happens when an economycollapses under the weight of unsustainable debt. One of the mostchilling is Argentina in 2001. When the International Monetary Fund cutoff its support for the country’s escalating debt, the effect wascatastrophic: the value of the national currency plunged, decimatingthe savings of millions. The resulting surge in inflation and suddenslowdown in consumer spending put thousands of businesses intobankruptcy within weeks. That, in turn, put further millions out ofwork and pushed one of South America’s biggest economies into apunishing recession.
As unfathomable as it may seem, mosteconomists think something like that could happen in the United States."If foreign investors look at the long-run outlook for the federalbudget and decide there is going to be a crash, you get a financialpanic," Bivens explains. "Interest rates spike. That causes a hugerecession. You’ll have the dollar falling fast, so maybe inflation issparked at the same time." And if interest rates spike, that wouldsqueeze millions of U.S. consumers who have taken out loans against therising value of their homes in recent years. A sudden hit to the realestate market would further constrain consumers’ wallets, leading to acycle of lower spending, and deeper recession, Bivens says.
Kotlikoff outlines a frighteningly similar scenario in his book The Coming Generational Storm.In it, he describes America in 2030 hurting from "unprecedented" taxlevels, drastic reductions to social programs, unsustainable borrowing,spiralling inflation and an explosion in tax evasion. He compares theUnited States in 25 years to what Russia’s economy looked like at thethe turn of the millennium.
When he considers the numbers, Bivenscan’t disagree with Kotlikoff’s forecast. "You’ve got all theingredients for a pretty spectacular crash that a country as rich asthe U.S. should just never be even close to flirting with," he says."Another six or seven years along this path and I think we’ll really beflirting with it. It’s rather insane."