Can They Pay it Back?: U.S. about to Go Broke
When Peter Schiff was making the rounds on U.S. cable news shows in 2007, warning about the collapse of the housing market, anchors and fellow guests literally laughed in his face when he launched into his gloomy predictions. That kind of meltdown could never happen, they said. The ECONOMY was on rock-solid ground. In those rosier economic days, Schiff, the president of Darien, Conn.'s Euro Pacific Capital, was repeatedly cast as a successful broker who'd gone off the deep end.
These days, a vindicated Schiff is back on the talk show circuit with an even darker message. The current RECESSION, he argues, is only the beginning of a larger economic restructuring. The American economy has been destroyed by years of reckless spending and borrowing. And now, the U.S. government is so deeply in debt that at some point in the very near future, he says, its lenders - namely China - are going to come to their senses and cut America off. "We can't have one country that just borrows and one country that just consumes that's supported by the rest of the world. It doesn't work." When this system collapses - and it inevitably must, he insists - inflation will run wild as the U.S. prints money to support its spending habit. Interest rates will jump and everyone will suffer. The real day of reckoning is still to come.
This time around, nobody is laughing at Schiff. Anyone who has taken so much as a cursory glance at America's financial books and seen the masses of red ink has come to a grim conclusion: not only is the situation no longer sustainable, it's rapidly getting worse. The Congressional Budget Office estimates that the U.S. deficit this year will amount to $1.8 trillion (all figures in US$) and it sees the government spending about $1.2 trillion more than it brings in for each of the next several years. That's one of the more optimistic forecasts. Others say that over the next few decades, revenues will remain relatively flat while spending soars as demand grows for benefits such as health care for an aging population. The U.S. debt now stands at over $10 trillion and will hit $17 trillion within the decade, according to the Congressional Budget Office - a number so large that it will nearly match the entire yearly output of the world's most powerful country. In short, America is about to go broke and every Western country, including Canada, will pay the price.
What's alarming about the situation in the U.S. is just how quickly and easily the country found itself buried under a mountain of debt. Back in 2001, the Congressional Budget Office was estimating that by now, the U.S. should be running a healthy annual surplus - in fact it figured that when added together, the surpluses between 2001 and 2011 would total $5.6 trillion. At the time, it seemed like a reasonable projection. After all, in 2001 the government recorded a surplus amounting to $128 billion. But two important things happened since then that launched the U.S. into a very different future: the dot-com bust and George W. Bush. The recession that followed in 2001 caused tax revenues to fall and spending on social services to rise, taking a good bite out of those estimated budget surpluses. At the same time, newly elected president George W. Bush - emboldened by the surplus he'd inherited when he came to office - proceeded to dole out steep and widespread tax cuts, which cut revenue by about five per cent. That was followed by a new $530-billion drug benefit program in 2003. To top it all off, the wars in Iraq and Afghanistan caused defence spending to explode. (The bill for those wars so far: $830 billion.) In just four years, America's massive budget surplus was decimated and turned into a $400-billion annual deficit. Since then, it briefly showed signs of recovery, but when the recession hit in 2008, the deficit quickly plummeted back down to around $400 billion.
President Barack Obama hasn't helped matters. Faced with a severe recession he has had little choice but to push policies that have piled debt on top of debt. Nearly $3 trillion has been spent rescuing banks and the automakers (that's about as much as the entire government spent in all of 2008), and stimulus programs have added another $800 billion to the government's tab. "It's hard to overestimate the massive spending spree we've had in the United States over the past few years," says Brian Riedl, a budget analyst at the Heritage Foundation, a Washington-based research organization. Under Obama's budget, the debt-to-GDP ratio will double to 82 per cent by the end of the decade - a level not seen since the 1950s, when the U.S. was recovering from the Second World War.
But that's not the worst of it. The biggest spending is still to come. With 75 million baby boomers retiring, there will be massive new strains on social services in the coming years. Three programs alone - Medicare, Medicaid and Social Security - will create a $43-trillion liability over the next 75 years, says Riedl. That kind of spending would push America's debt-to-GDP ratio to levels that have only been touched by bankrupt Latin American nations. To cover these costs, the government would have to more than double income tax rates to more than 60 per cent - an option no lawmaker would dare consider.
These trends mean that even if Obama's stimulus spending packages wind down as planned and the economy recovers this year and next, there is still no hope whatsoever that deficits can be eliminated in the short term. This is an unprecedented position. After the Second World War, when the U.S. had a debt-to-GDP ratio of more than 100 per cent, nobody expected deficit spending to continue, and it didn't, says Alan Auerbach, an economist at the University of California, Berkeley, who has studied the debt problem. The deficits of the 1980s were also quickly erased. "The difference here is that things will continue to unravel because we're going to have rapidly growing entitlement spending and no comparable growth in taxes under current policy."
Add it all up and by the end of the decade, the interest payments alone on the debt will cost U.S. taxpayers $800 billion a year. That figure will rapidly worsen, as the money spent on interest payments is added to the deficits, which in turn are added to the debt, which leads to even higher interest payments. "The whole process can start to feed on itself," says Isabel Sawhill, a senior fellow at the Brookings Institution and a former budget official in the Clinton administration. "You get into a vicious cycle which can become explosive at some point." By 2040, those interest payments will eat up 30 per cent of government revenues, according to some estimates. Sooner or later, the U.S. will be handcuffed by its debt, with a diminishing ability to pay for basic services, from defence to infrastructure to education.
The dismal state of America's finances, and the prospect of decades of ballooning deficits, have understandably started to make the country's lenders a little nervous. The U.S. raises money by selling Treasury Securities, largely to foreign buyers. Lately, those investors have been increasingly wary of the stability of those treasuries, which were once considered the safest bet in the investing world. Demand at recent U.S. Treasury auctions has been weak, leading to slight rises in interest rates - a potentially troubling indicator. Late last month, well-known bond guru Bill Gross, founder of Pacific Investment Management Co., warned the U.S. could eventually lose its AAA investment grade ranking.
The largest buyer of U.S. debt is China, which held $768 billion worth of Treasury Securities as of March. Recently it has openly expressed concerns about America's ability to repay the loans. "Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried," said Chinese Premier Wen Jiabao at a news conference earlier this year. "I'd like to take this opportunity here to implore the United States to honour its words, stay a credible nation and ensure the safety of Chinese assets."
Those are the kinds of politically loaded statements that keep Schiff up at night. What happens if lenders like China and Japan come to the conclusion that their investments in America have turned out to be bad ones? "The fact that we squandered all the money they loaned us, and the fact that by lending us money they've contributed to our economy being less efficient and less productive, they're actually in a situation where the more money they lend us the less likely we are to pay them back," he says.
Many scoff at the idea that China will suddenly say "no more" to the U.S. After all, the two countries have had a mutually beneficial relationship for years. China lends money to the U.S. and the U.S. buys masses of consumer goods from China. What's more, it's a long-standing relationship and many doubt that China would want to upset the status quo. Schiff sees no logic in that argument. "That they'll keep lending indefinitely makes about as much sense as the argument that real estate prices have been rising, so they'll rise forever," he says. "Nothing that is unsustainable will go on forever."
But the thing is, China doesn't have to entirely cut off the U.S. to cause problems. Even if China decided to pull back slightly there would be consequences. The U.S. would still find itself short of the cash it needs to pay its bills, and like a homeowner who misses a mortgage payment, it would have to find that money somehow.
Regardless of precisely how and when this all unfolds, the dollar will inevitably become less valuable and interest rates will rise as the U.S. scrambles to attract new lenders. That will translate into inflation and higher interest rates for the average person, too. The cost of living will go up and the value of people's savings will decline. Canada would likely get dragged into the mess too, just as it was affected by the current downturn in the U.S. The question is how severely this will all hit. "We could have another economic crisis or we could simply have a termites-in-the-woodwork scenario where we gradually have an erosion of our standard of living and become a nation in decline," says Sawhill. At the very least, from here on in, the debt will act as a giant anchor, slowing whatever modest economic growth the U.S. can muster.
For the past five years or so, a small group of economists, researchers and former government officials have put on what they call the Fiscal Wake-Up Tour. It's a kind of travelling road show aimed at raising awareness among citizens about America's looming debt crisis. "We've been frustrated that there hasn't been more attention paid to [the debt] and that steps weren't taken earlier," says the Brookings Institution's Sawhill, who's taken part in the tour.
Lately, however, the issue has been getting more attention, say some of the tour's participants. The trouble is, nobody has any faith that this new-found interest will translate into any timely reaction from lawmakers. There really is no politically feasible solution to America's debt crisis at the moment. For starters, no amount of economic growth can erase the deficits the U.S. is now facing, says Susan Irving, the director of federal budget analysis at the U.S. Government Accountability Office, a congressional body that oversees how the government spends tax dollars. No matter what numbers they enter in their simulations, she says, they can't fix the problem.
That means any solution boils down to highly unpopular tax hikes and big spending cuts. To maintain the current debt-to-GDP ratio and prevent a debt explosion from happening over the next 75 years, the government would have to either raise revenues by 44 per cent or cut spending by 31 per cent, says Irving. It's clear that there's no appetite whatsoever for either of those options. Tax hikes are especially daunting when you consider that health care costs in the U.S. have been growing about two per cent faster than the economy. "You can't raise taxes fast enough to catch up," adds Irving.
Canadians know first-hand how hard and painful it can be to wrestle down a growing national debt. In the 1990s Canada embarked on an effort to slay its much more modest annual deficits. It worked, but not without sacrifice. We ended up with higher taxes and deep cuts to services like health care.
For the Americans, the first step is to at least "stop digging," says the Heritage Foundation's Riedl. "Take a step back and think twice before enacting [Obama's] very expensive proposals." Then, somehow, lawmakers need to get together and put some spending caps in the budget, he adds. Eventually, taxes will have to go up - on that point everyone can agree. The question now is whether this happens in the midst of a crisis, or in a more measured way, with some foresight and planning. "It's just tragic that we're not dealing with this now," says Auerbach. "If we do it under time pressure because suddenly U.S. interest rates are going up, it's not going to be nice."
But all of this is much easier said than done. What's happened in Washington so far is minor, says Sawhill, "a drop in the bucket ... or in the sea," she says. There are some signs that political pressure to curb deficit spending is growing (mostly from the opposition Republicans), but no agreement on how to proceed. Democrats generally fear the looming spending cuts while Republicans fear the taxes. "Those fears are understandable - but they should be outweighed by the fear of what will happen if we fail, if our debts overwhelm us, and if the fiscal meltdown comes," said House majority leader Steny Hoyer, in a speech last month.
Riedl finds some cause for optimism in the fact that at least Americans, both inside and outside of Washington, are finally talking about the debt problem after ignoring it for all these years. That may be one of the few positive outcomes of the economic downturn: it has led Americans to slowly begin to acknowledge the elephant in the room. "The financial crisis has shown a lot of people that dire economic calamities can happen," he says.
Schiff, the broker-turned-celebrity-prognosticator, is concerned enough about such a calamity that he says he's now considering taking his message straight to Washington and running for a seat in the U.S. Senate. His threat to enter politics, which he first made last week on The Daily Show with Jon Stewart, has caused some buzz in Washington. But much as he seems to crave the spotlight, he says there's another reason for his bid. "I'd do it because somebody has got to do something to stop this. It's going to end in misery."
See also CANADIAN-AMERICAN RELATIONS, ECONOMIC.
Maclean's June 29, 2009