“America cannot be great if we go broke,” opined Erskine Bowles and Alan Simpson, co-chairmen of President Obama’s deficit reform commission, when they issued their controversial budget recommendations last month. Going broke? What exactly does it mean for a government to go broke? Countries don’t file for bankruptcy. Does it mean running out of money – even though the government will continue to bring in trillions of dollars in tax revenue and the Federal Reserve can print as much money as it wants?
Alice V. Rivlin and former Sen. Pete V. Domenici got a little more specific in a report, “Restoring America’s Future,” they issued nearly a month ago:
Federal spending is projected to rise substantially faster than revenues, and the government will be forced to borrow ever-increasing amounts. Federal debt will rise to unmanageable levels, which will push interest rates up, endanger our prosperity and make us increasingly vulnerable to the dictates of our creditors, including nations whose interests may differ from ours.
Higher interest rates sound unpleasant, but we’ve had them before, and we lived to tell the tale. As for being vulnerable to the “dictates” of unnamed creditors (who sound suspiciously like the Chinese), what does that mean? Could China command us to cut spending and raise taxes like the European Union dishes out orders to Greece and Ireland? Don’t be vague – spell it out.
If Americans cannot imagine the unimaginable – just as they could not conceive of Arab hijackers ramming planes into the World Trade Center – we will never take the painful steps required to avert calamity. Americans need to know the financial endgame they’re trying to avoid.
Here is what the budget hawks are implying but not coming right out and saying:
In the absence of budgetary reform, interest rates for U.S. Treasury securities will rise as investors demand higher yields to compensate for the higher risk of default. A crisis – call it “Boomergeddon” – will be precipitated by the inability of the U.S. Treasury to finance its multitrillion-dollar debt ($13.7 trillion today, more than $20 trillion by 2020). One day, the Treasury will hold an auction, and there won’t be any buyers. The Federal Reserve will step in as a buyer of last resort, conjuring money from the ether to buy the bonds. The injection of massive liquidity into the financial system will trigger fears of hyperinflation, causing the dollar to plunge and interest rates to rise.
If the resources of the European Union and International Monetary Fund are stretched to rescue the finances of tiny Greece (external national debt about $300 billion) and Ireland (about $120 billion), the United States will be not only too big to fail but too big to bail out.
Government will be able to spend only what it can bring in through taxes. About 40 percent of the budget, a sum equivalent to 9 percent to 10 percent of the gross domestic product, will go poof. Consider the impact of such massive fiscal stimulus in reverse – “suckulus,” if you will. Absent emergency action by the government, the economy will plunge into a depression roughly three times more acute than the recession we just experienced.
Congress could cut spending programs or raise taxes, but that would only aggravate the Keynesian contraction. The Treasury could repudiate all or part of the national debt – most likely the debt owed to foreigners, who can’t vote or contribute to political campaigns – in the hope of relieving the crushing interest obligations. But that would trigger an Argentine-style capital flight, crippling the dollar and driving interest rates higher. Alternatively, the Fed could cover the spending shortfall by creating money. But that would ignite a horrendous inflation, which would batter the dollar and send interest rates into the stratosphere.
Adding to the financial chaos, politicians will intervene with policies to salve the pain – protective tariffs, capital controls, wage-price controls or some other imbecility – that will compound the economic damage. Meanwhile, economic disruption will ricochet around the world, prompting other governments to pursue beggar-thy-neighbor policies.
Such is the nightmare scenario if we fail to balance the budget. Congress is running out of time for posturing, temporizing and blaming the other guy. We have a window of opportunity of four or five years to avert fiscal Armageddon. But if we can’t paint a believable picture of what that might entail, it may be impossible to motivate Americans to make the sacrifices that need to be made.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.