In 2000, the United States had a balanced federal budget. Today, America has a deficit problem that threatens the country's future. It is compounded by former President George W. Bush's fiscal recklessness, the economic crisis that began with September 2008's financial collapse, President Barack Obama's spending ambitions, and the mysterious ability of the weakened Republican Party to create political deadlock in Congress.
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Under Bush, spending was increased, taxes were cut, and the result was huge deficits financed by borrowing. Then came the "Great Recession," as it is being called (I call it a depression because of its probable long-term economic and political consequences). The public debt (the important component of the national debt -- the part that is more than an accounting entity -- that is really owed), which the Bush administration's deficits had caused to double, soared further. It soared because of falling tax revenues, rising unemployment benefits, and rising government expenditures to fight the depression (such as Obama's $787 billion stimulus plan). The public debt reached $7.5 trillion by the end of fiscal year 2009 (Sept. 30, 2009) and is expected to increase another $1.6 trillion this fiscal year and another $1.3 trillion next year. That means it may exceed $10 trillion by Sept. 30, 2011. Almost half the debt is owned by foreigners, and the interest payments to them are a drain on American wealth. Interest rates on the debt will rise as the world economy recovers, increasing competition for capital.
The United States has a deeply wounded economy. At this writing, transfer payments by the government to individuals and families (Social Security, unemployment benefits, tax credits, etc.) exceed the taxes being collected from the household sector. At the same time, private investment net of depreciation is negative. This means that private savings are being borrowed by the government, combined with the government's foreign borrowing, and then transferred to households to enable them to maintain their accustomed level of consumption. People are saving more, but government borrowing overwhelms their saving, with the result that aggregate saving -- public plus private -- is negative. So: negative savings, negative private investment, an incredible ratio of household debt to disposable income (1.25 to 1, though down from 1.39 to 1 in 2007), massive government borrowing to finance private consumption -- not a nice combination.
When the American economy does finally recover, tax revenues will rise, unemployment benefits will fall, and depression-fighting programs will end -- so annual deficits should decline. But realistically, this means only that the public debt will grow more slowly than it will be growing this year and next.
The international dimensions of public debt growing slowly or rapidly from a very high level deserve consideration. At some point, the value of the dollar relative to other currencies will fall; this effect will be accelerated if, as is not unlikely, the "easy money" policy of the Federal Reserve, instituted to fight the depression, results in significant inflation. A falling dollar may endanger the dollar's status as an international reserve currency. Foreign contracts are often denominated in dollars rather than in a local currency. If an oil producer in a Middle Eastern country sells oil to a refinery in a South American country, neither party may be happy to have payment made in the currency of the other party's country because by the time payment is due, the value of the currency may have changed to the advantage of the other party. By providing that payment will be made in U.S. dollars, the parties can hedge against changes in the value of the local currencies. For such hedging to be effective, however, the value of the dollar has to be stable. If it becomes unstable, the dollar may cease to be the principal international reserve currency, accounting at present for almost two-thirds of international currency reserves -- a status that allows the United States to run a trade deficit (up to a point) costlessly because foreign countries need to hold U.S. dollar reserves to supply dollars in exchange for local currencies to businesses that have dollar-denominated contracts.
It is true that as growing deficits reduce the value of the dollar relative to other currencies, while making imports more expensive, American exports will grow, implying a shift of workers and capital from services to manufacturing. But the shift, reversing a long-term decline in manufacturing relative to services, may be a painful and protracted one, just as China's transition from an export-led manufacturing economy to a domestic consumer economy is likely to be painful and protracted. Any major restructuring of a country's economy will produce heavy unemployment as a byproduct until the restructuring is complete.
The adjustments that will be needed -- if the economy does not outgrow an increasing burden of debt -- to maintain the U.S. economic position in the world may be especially painful and difficult because of features of the American political scene that suggest that the country might be becoming in important respects ungovernable. The perfection of interest-group politics has brought about a situation in which, to exaggerate just a bit, taxes can't be increased, spending programs can't be cut, and new spending is irresistible. If one may judge by the Bush administration's fiscal improvidence, these tendencies are bipartisan.
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