As creditors get edgy, US keeps spending
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AMID all the coverage of Barack Obama's victory, this week's financial pages contained some disquieting news from Taiwan. Financial regulators there ordered the country's insurance companies to cut their holdings of bonds issued by
At $278 billion, Taiwan's foreign exchange reserves are the fifth largest in the world, after China, Japan, Russia, and India. At last count, the country held $88 billion of US government and agency securities, making it one of our largest official creditors. So, if the Taiwanese are getting nervous about our credit, how much longer can we go on spending freely and assuming that foreigners will buy up US bonds to pay for it?
Maybe the Taiwanese - and others - are getting edgy at the breathtaking speed with which we are piling up obligations to the rest of the world. George W. Bush's presidency saw more new borrowing than occurred during all the previous 42 presidents combined. The federal debt now totals $10.6 trillion - not including $1.7 trillion more in unsecured loans that we have taken on for Freddie Mac and Fannie Mae, and an undetermined amount of debt for the bailouts of Bear Stearns, AIG, and the Wall Street mortgage mess. The entire Iraq war has been paid for by debt (including raiding the Social Security surplus and borrowing from China). And more borrowing is on the way. Congress is likely to pass another economic stimulus package to combat recession, and tax revenues are likely to drop. The budget deficit may climb to $700 billion in 2009 - aproaching 5 percent of gross domestic product.
If the United States were a developing country, there would be talk of a looming debt crisis and the need to call in the International Monetary Fund to impose financial discipline. We are spared this fate largely because the dollar remains the world's reserve currency. We can print money to pay our debts, so the likelihood of default is remote.
But we cannot ignore warning signs on the horizon. The global financial crisis is denting the huge foreign exchange reserves of governments that bankrolled the Bush spending spree. If the world's appetite for US Treasury bonds begins to wane, that would push up our long-term interest rates and would also send the dollar lower.
However, the size of global financial markets is such that we are still far from maxing out our national credit card. Instead, what the Obama administration needs to worry about is how much the country's debt mountain will crimp our ability to pay for the type of change we just voted for - lower taxes, better healthcare, public investment in new forms of energy, and a renewal of our aging roads and bridges.
The math is simple. Federal taxes bring in $2.5 trillion a year for the government. But we spend almost $3 trillion. Of this, over half is gobbled up by "entitlement" programs such as Medicare, Social Security, veterans and federal retirement pensions, and a further $700 billion by the Defense Department. That leaves less than $800 billion for everything else the government does - but interest payments on the debt soak up $250 billion. As the debt grows, and interest rates rise, interest payments will squeeze more and more of the budget, leaving us with only two unpleasant options - raise taxes or cut spending. The longer we wait, the more painful the choice becomes.
This trend is unsustainable. Americans need to realize that the so-called Bush tax cuts (which disproportionately benefited the rich) were really just loans that our kids will need to repay. Wealthier Americans need to contribute more today. At the same time, we must base our budgets on the actual cost of providing services, instead of historical spending patterns. The Defense Department flunks its financial audit every year. We cannot afford to exempt it from this scrutiny. Finally, we need to roll up our sleeves and tackle the entitlement programs.
If we take all of these steps, our future borrowing needs will be reduced, and those who lend to us will maintain confidence in the United States as a creditor.
Linda Bilmes, an assistant secretary of commerce in the Clinton administration, teaches public finance at the Harvard Kennedy School. She is co-author of "The Three Trillion Dollar War: the True Cost of the Iraq Conflict."
