America's Debt Dilemma
This past July CBO issued a study of the possibility that the United States could face a fiscal crisis in the not-too-distant future. By "fiscal crisis" CBO means a scenario in "which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates." In other words, the federal government would be faced with the following choices: pay unsustainable rates of interest on further borrowing, drastically raise taxes, slash spending, or create money. All of these options are bad.
The first option, an interest rate shock, would involve substantial crowding out, as high interest rates shut off lines of credit to productive business investment. If interest rates sharply increased and investment in future productivity fell, the U.S. debt would become increasingly difficult to service. The endgame would almost certainly involve United States defaulting on their debt, or else monetizing it. Historically, when countries take this route once, they take it repeatedly, because short-term political concerns make this attractive to politicians. It's the route to banana-republicdom.
The second option, drastic tax increases, is unlikely so long as officials face honest elections. The levels of taxation required might result in doubling of taxes as a percent of GDP, or more. Where's the constituency for that?
Slashing spending, option three, sounds great to those of us who believe government is too large and has overstepped its bounds... but there's a great difference between a controlled, careful planned reduction of spending, and a sudden shock. The states which are suffering budget crises are examples, as are Greece, France, and the U.K. It's all fine and well to say that various government services should be privately provided -- something I agree with -- and quite another to suddenly eliminate them without any time or institutional groundwork for private provision. If people are dependent on government services, suddenly slashing them creates turmoil -- personal, economic, and ultimately political. It's destructive. On a large scale, it generates political turmoil and violence, as France and Greece are seeing as people face slashed living standards. Or consider the U.K., where defense is being cut by an immediate 8%, with more to follow.
Well, what about option four, creating money? Ah, if only it were so easy, Robert Mugabe's Zimbabwe would be a wealthy country. Alas, it doesn't work. Destroying the currency might bail out the government, but does so at the expense of the citizens. It doesn't make sense even on a small scale: even Robert Reich understands this is not the path to prosperity.
Of course, this is all speculative long-run stuff, might never come to pass, not of immediate concern... right?
No. The CBO report points out we'll have a public-debt-to-GDP ratio of 60% by the end of this year. In ten years (2020) it is projected to be 90% under the "alternative fiscal scenario," and 110% by 2025 (Greece's crisis level). Somewhat disturbingly, 40% is the threshold at which Reinhart and Rogoff found that countries become "at risk" for serial crises. And unfortunately, if you read the fine print of the CBO report, it's clear that the alternative scenario is an optimistic estimate.
This is grim stuff, and it's a problem we ought to be taking very seriously and tackling immediately, because the longer we put it off, the worse the ultimate reckoning. It's not something that can be solved painlessly. Cutting waste and inefficiency won't do it -- the long-term CBO projections show that we could cut discretionary spending to zero and still not solve the problem. Cutting discretionary spending to zero means eliminating every government program except for Medicare, Medicaid, Social Security, and interest payments. Furthermore, the levels of taxation that would be required to sustain current planned (promised) spending on Medicare, Medicaid, Social Security, and interest payments are draconian and probably unsustainable.
Neither political party seems serious about addressing this debt dilemma, something I will address in future posts. But it is real, and if we do not address it now, the crisis is coming, and it will be addressed, one way or another. Reality isn't optional.
Learn about Mr. Stolyarov's novel, Eden against the Colossus, here.