|
Is America going
broke?
Macleans.ca (Canada)
STEVE MAICH
March 02, 2005
Is America going broke?
Record deficits, colossal debt and no clear plan for digging
itself out. If the U.S. sinks, it will take Canada down with
it.
STEVE MAICH
David Walker can see the future, and it scares the hell out of
him.
That wouldn't be terribly unusual if he were one of the
thousands of lobbyists, legislators and activists crawling all
over Washington on any given day, pontificating about the urgency
of their pet issues. There is a thriving industry here built on
pushing policy prescriptions for every ailment, real or imagined.
But Walker isn't a lobbyist or an activist, he's an accountant.
His title is comptroller general of the United States, which
makes him the head auditor for the most important and powerful
government in the world. And he's desperately trying to get a
message out to anyone who'll listen: the United States of
America's public finances are a shambles. They're getting rapidly
worse. And if something major isn't done soon to solve the
country's intractable budget problems, the world will face an
economic shakeup unlike anything ever seen before.
Seated in his wood-panelled office in downtown Washington,
Walker measures his words, trying to walk the fine line between
raising an alarm and fostering panic. He cringes when he hears
prominent economists warning about a financial "Armageddon," but
he makes no bones about the fact the situation is dire. "I don't
like using words that are overly inflammatory," he says, leaning
forward in his chair. "At the same time, I think it is critically
important that the American people, as well as their elected
representatives, get a better understanding of just how serious
our situation is."
THE NUMBERS are staggering -- a US$43-trillion hole in
America's public finances that's getting worse every day. And the
stakes are almost inconceivable for a generation of politicians
and voters raised in relative prosperity, who've never known
severe economic hardship. But that plush North American lifestyle
to which we've all grown accustomed has been bought on credit,
and the bill is rapidly nearing its due date. If the United
States can't find a way to pay up, the results will spill beyond
national borders, spreading economic misery far and wide. In
Canada, the country whose financial well-being is most tightly
tied to trade with the U.S., there wouldn't be a single region or
industry left untouched by a fiscal shock south of the
border.
It's the looming presence of this potential crisis that brings
Walker to this office every day, through the doorway with the
words "Honesty Accountability Reliability" inscribed above, in
hopes that someone will listen and take up the challenge before
it's too 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 then figure out how we're going to fill the
hole."
HOW DID THE U.S. GET INTO THIS MESS?
In January 2001, George W. Bush took over leadership of a nation
that was on its most solid financial footing in decades, thanks
to years of strong economic growth and a booming stock market.
That very month, the Congressional Budget Office projected that
the federal government could expect US$5.6 trillion in surpluses
over the coming 10 years. The key political issue of the day was
how to spend the windfall. Bush's team was determined to return
the money to the voters in the form of massive and widespread tax
relief. What the world didn't know was that this surplus cash was
largely illusory, the result of faulty bookkeeping.
The CBO's rosy outlook was based on a few deeply flawed
assumptions, in particular that most government spending would
not exceed the pace of inflation over the following decade, even
though the rest of the economy and tax revenues were projected to
grow much faster. Laurence Kotlikoff, a professor of economics at
Boston University and a prominent critic of U.S. budgetary
planning, released a paper that year drawing attention to what he
called the CBO's "fiscal fantasy." But his was a single, lonely
voice, and few on Capitol Hill were listening. The tax-cut agenda
had taken hold, and there would be no stopping it.
The CBO and other agencies have since gone back and found that
a more realistic surplus projection would have been US$2.2
trillion -- over 60 per cent less than initially thought. And
that cushion quickly disappeared as Bush whittled or eliminated
one tax provision after another, from the marriage tax and
personal income tax rates to capital gains, gifts and dividends.
The Center for Budget and Policy Priorities, a Washington think
tank, estimates that between 2001 and 2004, federal tax revenue
dropped by some US$600 billion. Most of the tax cuts introduced
so far are temporary, but the Republicans have made it clear they
intend to make the reductions permanent before the end of the
current term.
In the midst of this tax-relief bonanza, and nine months into
the new President's first mandate, came Sept. 11. The horror of
the terrorist attacks profoundly changed the American public's
attitude toward security and defence almost overnight. Within
months, the U.S. military was on the ground in Afghanistan
attacking terrorist camps and overthrowing the Taliban regime.
From there, the troops moved on to Iraq. Between 2001 and 2004,
the annual budget for the Pentagon and domestic security rose by
US$87.1 billion, an increase of 27.5 per cent in four years. In
the process, a budget that had a surplus of US$128 billion in
2001 crumbled into a deficit of US$412 billion last year -- the
biggest annual shortfall in United States history.
But that's just one symptom of a much deeper fiscal problem.
The U.S. is heading for a massive demographic shift as baby
boomers start retiring in three years. As they do, the costs of
providing social programs and health care are going to soar.
"It's not the deficits of today that are the big problem," says
Josh Bivens, an economist with the non-partisan Economic Policy
Institute in D.C. "It's that, if you make the Bush tax cuts
permanent, you're going to have deficits as far as the eye can
see."
HOW BIG IS THE PROBLEM?
A trillion is a hard number to wrap your head around. Most people
know it's a thousand billion -- 12 zeroes -- but even that is
difficult to fathom in terms of value. So think of it like this:
a trillion U.S. dollars is roughly the size of the entire
Canadian economy. The world's six biggest oil companies had
combined 2004 revenues just shy of US$1 trillion. And if you
piled a trillion dollars in $1,000 bills, the stack would be more
than 109 km high.
As of February, the U.S. national debt stood at US$7.7
trillion. And this year, the country is projecting another record
deficit of US$427 billion, increasing its debt by about US$1.2
billion a day. Thanks to low interest rates, the cost of
borrowing all that money remains relatively low, amounting to
about 8.6 per cent of the federal budget for 2005. But when rates
rise, so will the cost of carrying that debt, and current White
House forecasts suggest that by 2010, those yearly costs will hit
US$314 billion.
But even those projections don't adequately capture the depth
of America's financial hole. For one thing, current budget
estimates do not include the costs of the ongoing military
campaigns in Iraq and Afghanistan, which are expected to require
an additional US$80 billion in funding over the next year or so.
The budget also does not factor in any costs associated with the
President's plan to reform Social Security, which would give
people the option of diverting some of their tax contributions
into private retirement accounts they manage themselves. That
plan will call for between US$1 trillion and US$2 trillion in
additional government borrowing over the next decade. Bush has
proposed cutting the budget deficit in half by 2010, but that
strategy doesn't take into account his pledges to make permanent
many of those temporary tax reductions introduced in 2001 and
2002, not to mention other tax cuts promised but not yet
implemented.
What's more, none of this even begins to deal with the most
pressing challenge of all: how to pay for the sunset years and
medical costs of about 77 million baby boomers getting set to
retire. Walker refers to this as a "demographic tidal wave"
coming to swamp the country's finances. He estimates that when
you take into account the unfunded liabilities of Social
Security, Medicare and Medicaid -- programs that together
comprise the heart of the U.S. social safety net, paying pension
and health-care costs for the 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 20 times the federal
government's annual tax revenues. And some actuaries think even
that number understates the size of the problem.
To most observers, it's becoming increasingly obvious that,
within the next 10 years, the U.S. government will simply not be
able to borrow money fast enough to keep up with its exploding
expenses. That has huge implications for everything Americans do,
from funding the military to protecting the environment. The
Economic Policy Institute recently projected that under the
current tax regime, by 2014 all government revenue would be
consumed by four areas of spending: health care for the elderly
and the poor, Social Security for retirees, national defence and
interest on the debt. There will be no money left for such
fundamental initiatives as education, transportation or justice,
which means the government would be forced into ever-escalating
borrowing to pay for basic programs. Walker's department projects
that, under the current tax rates, interest costs on the
skyrocketing national debt would be about half of all government
tax revenues by 2031. Ten years later, the cost of servicing the
debt will exceed all government revenues.
Laurence Kotlikoff described this burgeoning crisis four years
ago in a paper entitled "The Coming Generational Storm." Last
year, he provided a dark summary of the situation in a Fortune
magazine article. "The U.S. government is effectively bankrupt,"
he wrote. The available options to close the fiscal gap? Hike
income taxes by 78 per cent; slash Social Security and Medicare
benefits by more than half; or eliminate all other discretionary
spending. "That," he concludes, "is America's menu of pain."
HOW MUCH LONGER CAN THIS SITUATION GO ON?
The United States is the world's best customer. It buys far more
from foreign countries than it sells to them, resulting in a
sizable trade deficit. It also spends more on public programs
than it collects in tax revenues. And to pay for all these
outlays, the U.S. must attract mountains of foreign capital each
year, which essentially amounts to borrowing from foreign
governments and investors. This is commonly referred to as the
current accounts deficit -- which was running at US$665 billion
last year.
Those foreign countries don't lend out of the goodness of
their hearts; for the most part they lend because the U.S. uses
that money to buy goods from them and other nations. In many
ways, the prosperity of the developed world, including Canada,
Europe and parts of Asia, has been financed over several decades
by America's rampant spending, says David Rosenberg, a Canadian
who is chief North American economist for Merrill Lynch in New
York. In Canada's case, by year-end this country had sold $8.8
billion more in goods to the U.S. than we bought from it --
despite the loonie's sharp rise against the greenback that made
Canadian exports less affordable to Americans.
But foreign investors cannot go on forever supporting U.S.
spending. A banker who holds your mortgage and car loan will get
nervous if you keep coming back to up the limit on your credit
cards, and international debt markets work in much the same way.
The question becomes, how much longer will those investors be
willing to lend to the U.S., especially at the current low
interest rates, when the country appears to have no plan for
meeting its long-term funding needs? The issue is even more
pressing given the fact that the U.S. dollar has been falling for
more than a year, decimating returns for those foreigners who
invest in U.S. bonds.
Stephen Roach, chief economist at Morgan Stanley, is an
outspoken critic of U.S. fiscal policy and has long warned that
America's increasing reliance on foreign lending puts it at risk
of a major economic shock. A sudden drop in the dollar could
trigger, among other things, a stock market crash, a plunge in
the real estate market, a deep recession, or all of the above.
"There's nothing stable about America's dependence on the
kindness of strangers," Roach wrote in a report last summer. "The
funding of America is an accident waiting to happen."
At a recent meeting with fund managers in Boston, Roach said
he believes there is a 90 per cent chance the country's rampant
borrowing will eventually lead to a disaster for the economy.
Others, including former U.S. treasury secretary Lawrence Summers
and former president Bill Clinton, use less inflammatory language
but have also warned that the size of U.S. deficits could
compromise the nation's foreign policy and trade and security
goals. For example, how long can Washington stick to its
commitment to defend Taiwan against Chinese aggression when it
borrows so heavily from China to support the American
economy?
David Rosenberg scoffs at alarmists like Roach, but he does
acknowledge the current fiscal path is unsustainable. He quotes
economist Herbert Stein's old maxim: "Anything that cannot go on
forever, will stop."
WHY SHOULD WE CARE?
History provides some harrowing examples of what happens when an
economy collapses under the weight of unsustainable debt. One of
the most chilling is Argentina in 2001. When the International
Monetary Fund cut off its support for the country's escalating
debt, the effect was catastrophic: the value of the national
currency plunged, decimating the savings of millions. The
resulting surge in inflation and sudden slowdown in consumer
spending put thousands of businesses into bankruptcy within
weeks. That, in turn, put further millions out of work and pushed
one of South America's biggest economies into a punishing
recession.
As unfathomable as it may seem, most economists think
something like that could happen in the United States. "If
foreign investors look at the long-run outlook for the federal
budget and decide there is going to be a crash, you get a
financial panic," Bivens explains. "Interest rates spike. That
causes a huge recession. You'll have the dollar falling fast, so
maybe inflation is sparked at the same time." And if interest
rates spike, that would squeeze millions of U.S. consumers who
have taken out loans against the rising value of their homes in
recent years. A sudden hit to the real estate market would
further constrain consumers' wallets, leading to a cycle 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" tax levels, drastic
reductions to social programs, unsustainable borrowing,
spiralling inflation and an explosion in tax evasion. He compares
the United States in 25 years to what Russia's economy looked
like at the the turn of the millennium.
When he considers the numbers, Bivens can't disagree with
Kotlikoff's forecast. "You've got all the ingredients for a
pretty spectacular crash that a country as rich as the 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 be flirting with it. It's rather insane."
And this insane behaviour is a huge problem for everyone else
because of America's importance to the world economy. Literally
millions of workers in Canada, the U.K., Germany, Japan and
elsewhere are directly or indirectly reliant on a healthy U.S.
market for their jobs. "If suddenly Americans were unable to buy
those goods from those countries, the countries would have to
very quickly figure out how to keep their people employed,"
Bivens explains. Accordingly, most economists agree that a severe
downturn in the United States would drag the rest of the world
down with it. "If a country as big as the U.S. gets sick,
everybody's gonna get sick," says Bivens.
That is a reality Canadians don't seem to fully grasp. A
recent Maclean's/Rogers Media poll found only 41 per cent agree
that the domestic economy is closely tied to that of the U.S.; 11
per cent choose to believe the two economies are not at all
interrelated. In reality, virtually every region of the country
and every major industry -- forestry, energy, mining, auto
manufacturing, agriculture, technology -- depends on U.S. demand
for its prosperity. If American consumers are suffering under
surging unemployment, spiking interest rates, collapsing housing
prices and rising inflation, those same forces will inevitably
spill over into Canada.
Rosenberg, for one, believes the U.S. will restructure its
fiscal policy to avoid a major crash -- but even such a process
of reform is sure to have negative effects on trading partners
like Canada. To close its fiscal gap and reduce its need to
borrow abroad, the U.S. must find ways to boost its exports while
slowing imports. In other words, it must make it more difficult
for other countries to sell into its market. This is what
economists refer to as a "beggar thy neighbour" policy. "For the
world economy, this means the free ride is over," Rosenberg says.
"The days of partying on the U.S.'s fiscal Ferris wheel are over.
It's done."
HOW CAN AMERICA FIX THE PROBLEM?
On Nov. 1, 2000, as George W. Bush was campaigning for the White
House, he warned an audience in Minneapolis that the Democrats
would lead the nation into a future of higher taxes and slower
economic growth that "could mean an end to this nation's
prosperity." Bush won the election in part by portraying himself
as an antidote to tax-and-spend liberals. Yet despite this bold
austerity rhetoric, discretionary spending rose 23 per cent in
Bush's first term. Just over four years after harping on the
dangers of fiscal irresponsibility, the President is on his way
to making his own warnings a reality.
Virtually every reputable independent observer who has looked
at the United States budget shortfall concludes that some
combination of significant tax increases and major spending cuts
is unavoidable. But making those reforms happen, and closing that
budget gap, will require the kind of deft touch used to dismantle
a bomb. The American currency must be slowly, carefully managed
lower to boost U.S. exports, but without triggering a sudden
plunge in the greenback that could spark a devastating jump in
inflation. Interest rates must gradually rise to ward off
inflation and encourage consumers to save more of their earnings.
Spending must be reined in, but not so severely that it
compromises U.S. security and other public priorities. And taxes
must be raised, but not so drastically that they stunt economic
growth.
In many ways, the U.S. must now emulate the program that
Canada instituted in the 1990s to bring its deficit spending and
surging national debt under control. That was done with higher
taxes, billions in spending cuts and a sharp drop in the dollar's
value, combined with healthy economic growth. But south of the
border the size of the challenge is much larger, the stakes are
higher, and it seems clear the standard of living that millions
of Americans have come to take for granted will have to
change.
Walker stresses the need to make "tough decisions," and none
will be tougher than tackling the runaway costs of providing
health-care coverage for the elderly and the poor. Health
spending in the U.S. is projected to jump 63 per cent by 2010,
and to continue rising even faster after that. Most analysts
agree that, at some point, the government must find a way to
clamp down on those costs, yet any cuts in coverage are sure to
raise an outcry from the swelling ranks of senior citizens -- a
highly influential voting bloc.
Academics have proposed such reforms as a national retail
sales tax, a luxury tax and a rollback of all tax cuts enacted
since 2001. Others are calling for increased funding for the
Internal Revenue Service to catch tax cheaters. Many insist there
must be increases to Medicare premiums, as well as massive
cutbacks in a wide range of social programs. But telling voters
that they will have to pay more in taxes for fewer services is
not an easy sell, and so far no politician has been willing to
try it. In February, Bush tabled a proposed budget that would
eliminate or trim back 150 government programs, but even with
that, the U.S. would be racking up deficits well in excess of
US$200 billion for years to come. "They're not being serious
about austerity at all," Bivens says. "They're talking about very
big cuts to very small programs. They mean a lot to the people
getting them, but it's pennies in the overall fiscal
problem."
James Horney spent more than seven years as a staffer at the
Congressional Budget Office and now does analysis for the Center
on Budget and Policy Priorities, a non-partisan think tank in
Washington. He says the solution to the debt problem can only
emerge when both parties in Congress and the President sit down
to work out a "grand bargain" that includes concessions on both
taxes and program spending, and a strategy for reassuring
international lenders. "It requires a deal in which everything is
on the table and everyone is at the table," Horney says. "One
just hopes it will happen before some major cataclysm."
Walker shares that hope, and clings to his own sense of
optimism. He says he has detected a noticeable shift in attitude
just in the past few months, as legislators slowly come to grips
with the inevitable financial reckoning. But he acknowledges
that, so far, there is little concrete progress to show for his
efforts. "The thing that is frustrating is that you can talk to
people and point to things, but that's all you can do," he says.
"You can lead them to water, but they have to drink. And they
better start drinking fast -- and soon."
To contact the writer, email:
steve.maich@macleans.rogers.com
|
|