Tuesday, February 2, 2010

The U.S. Budget Deficit

Walker Evans: Truck and Sign, 1930. 
Walker Evans Archive, The Metropolitan Museum of Art.

The federal budget deficit is larger than thought, and it is becoming a national-security threat.

The National Security Threat

The Wall Street Journal reports that the Federal government will borrow one of every three dollars it spends this year.  The problem is that U.S. citizens cannot lend the money, because they save so little.  Much of the money will have to be borrowed from foreign countries.

"We've reached a point now where there's an intimate link between our solvency and our national security," says Richard Haass, president of the Council on Foreign Relations and a senior national-security adviser in both the first and second Bush presidencies. "What's so discouraging is that our domestic politics don't seem to be up to the challenge. And the whole world is watching."

The Journal listed four ways that such a severe budget deficit threatens America's national security:
  • It makes America vulnerable to foreign pressures.  Because half of America's debt is in the hand of foreigners, a foreign central bank could put pressure on the U.S.
  • By accepting vendor financing from China, we are conferring a lot of financial leverage to them in particular.
  • Long-term national-security budgets are put at risk.  Debt service will crowd the defense budget.
  • The American model is being undermined before the rest of the world.
To this list I would add the following ways that the growing national debt harms national security:
  • America is saving so little that it is not able to invest in the human resources, plant and equipment, etc. needed to increase productivity and build a competitive position in a modernizing world.
  • The U.S. will become less socially stable as debt service crowds out social programs.  Citizens will become desperate, angry, and more prone to take extreme solutions.
  • The resulting brittleness of U.S. systems will amplify the impact of any future terrorist attacks, resource scarcity, environmental change, inflation, war, or other adverse events.
The last bullet could be expanded into a number of issues.  Living standards will decline because the Federal budget will be unable to afford the social safety net that US citizens have already paid for and are depending on: Social Security, Medicare, Medicaid.  Support for already stretched cities and states will wither.  Essential city and state services (roads, schools, police, fire, etc.) will have to be sacrificed.  Benefits for the unemployed will be cut.  Increased tax loads will discourage businesses, increase unemployment, and squeeze impoverished citizens even harder.  As America sinks, its disappointed citizens will see other areas of the world gain improving living conditions.  They will see "progress" fail in the U.S. and succeed elsewhere.

Otto Dix, Stormtroops Advancing under Gas, etching and aquatint, 1924.

Growing Deficit Estimates

In "White House to Paint Grim Fiscal Picture" Reuters reports that the budget deficit is larger than previously believed.  According to the White House's Office of Management and Budget, the deficit for the current fiscal year will be significantly higher than the $1.35 trillion figure forecast by the nonpartisan Congressional Budget Office last week.

Despite the President's proposal of a three-year freeze on some domestic programs to save $20 billion next year and $250 billion over the coming decade, that will not be enough to get deficits down permanently to the 3 percent of gross domestic product that most economists consider sustainable.  Deficits will still average roughly 4.5 percent of GDP over the coming decade, according to the White House estimate.  That's not all.

What happened to the entitlement problem that we have been expecting for some time?  It's still coming.  Deficits are expected to rise again toward the end of the decade due to the increasing cost of retirement and healthcare programs as the "baby boom" generation retires.  If we cannot bring the current deficit problems under control, we will be utterly swamped when the deficit is hit by the coming wave of baby boomer retirements.

Where to put the blame?  Despite the criticism of President Obama and his administration, most of the fiscal mess has been inherited from the previous administration of Republican George W. Bush, who cut taxes and created an expensive prescription drug-benefit while pursuing wars in Iraq and Afghanistan.

Blame also falls on Bush for the shortfall in tax revenues to fund the budget.  It was his administration whose monetary policies provided the loose money for the housing bubble, and it was his administration whose laissez regulatory policies failed to rein in the investment banks and mortgage companies.  The shortfall in revenues during the resulting depression is putting cities, states, and the Federal government further in the red.

Unsustainable Debt Levels

Bert Dohmen wrote a sobering piece last month in Forbes about "Trillions of Troubles Ahead" for U.S. debt.  He quotes his colleague Rob Arnott that "at all levels, federal, state, local and GSEs, the total public debt is now at 141% of GDP. That puts the United States in some elite company--only Japan, Lebanon and Zimbabwe are higher."

In adddition, household debt is 99% of GDP and corporate debt is 317% of GDP ("not even counting off-balance-sheet swaps and derivatives") -- both being the highest in the world.  Adding those to government debt at all levels, "our total debt is 557% of GDP."

Dohmen warns:  "The interest on the debt will consume all the tax revenues of the country in the not-too-distant future. Then there will be no way out but to create more debt in order to finance the old debt."

The article likens the situation of the U.S. to Japan, which has the highest debt-to-GDP level (227%) of any industrialized country.  Japan's recession has lasted for 19 years now and the stock market is down 75% from the 1990 high.  As bad as things have been for Japan, they could get worse.  Japan's demographics will make it more dependent on foreign creditors in the future, and Fitch has warned about a potential downgrade of Japan's debt.  This is not a good precedent for spendthrifts like the U.S.