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American Proigacy and American Power

The Consequences of Fiscal Irresponsibility

Roger C. Altman and Richard N. Haass

The U.S. government is incurring debt at a historically unprecedented and ultimately unsustainable rate. The Congressional Budget Oce projects that within ten years, federal debt could reach 90 percent of gdp, and even this estimate is probably too optimistic given the low rates of economic growth that the United States is experiencing and likely to see for years to come. The latest International Monetary Fund (imf) sta paper comes closer to the mark by projecting that federal debt could equal total gdp as soon as 2015. These levels approximate the relative indebtedness of Greece and Italy today. Leaving aside the period during and immediately after World War II, the United States has not been so indebted since recordkeeping began, in 1792. Right now, with dollar interest rates low and the currency more or less steady, this scal slide is more a matter of conversation than concern. But this calm will not last. As the worlds biggest borrower and the issuer of the worlds reserve currency, the United States will not be allowed to spend ten years leveraging itself to these unprecedented levels. If U.S. leaders do not act to curb this debt addiction, then the global capital markets will do so for them, forcing a sharp and punitive adjustment in scal policy. The result will be an age of American austerity. No category of federal spending will be spared, including entitlements and defense. Taxes on individuals and businesses will be raised. Economic growth, both in the United States and around the world, will suer. There will be profound consequences, not just for Americans standard of living but also for U.S. foreign policy and the coming era of international relations.
THE ROAD TO RUIN

R o ger C . A ltman is Chair and CEO of Evercore Partners. H e was U.S. D eputy Treasury Secretary in 199394. R ich ard N . H aass is President of the Council on Foreign Relations. H e was D irector of Policy P lanning at the U.S. State D epartment in 20013.

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It was only relatively recently that the United States became so indebted. Just 12 years ago, its national debt (dened as

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f ederaldebthel by the publc) w as i lne d i n i w i the l th ong-term hi stori average, cal around 35 percentofgdp. T he U .S. governm ent budget w as i surpl m eani s n us, ng that the totalam ount of debt w as shri nki FederalR eserve o ci s even publcl ng. al i y di scussed the possi lty thatal ofthe debt bii l m i be pai o. ght d A t that ti e,the U ni States had no m ted hi story ofexcessi federaldebt. T hi w as ve s not surpri ng si si nce,on scalm atters,i t has al ays been a conservati nati T he w ve on. one excepti w as the speci and sudden on al borrow i program to nance U .S. parti ng ci on i W orl W ar II,w hi caused pati n d ch debtto bri exceed 100 percentofgdp i ey n the m i d-1940s,before begi ng a steady nni return to tradi onall s. ti evel B ut over the rst ten years of thi cens tury,a fundam entalshi i scalpolcy ft n i occurred. W hen the G eorge W . B ush adm i strati took o ce,i i ti ni on t ni ated, and C ongress approved,three steps that turned those budget surpl uses i l nto arge deci T he 2001and 2003 tax cuts,w hi ts. ch w ilreduce federalrevenue by m ore than l $2 trilon over ten years,had the bi li ggest i pact. B ut addi the prescri on-drug m ng pti benet to M edi care al carri a huge so ed cost,as di the w ar i A fghani d n stan and, even m ore so,the w ar i Iraq. n T hese steps w ere al accom pani so ed by the outbreak of an especi l parti aly san peri i A m eri polti In C ongress, od n can i cs. the D em ocrati center of gravi m oved c ty l and the R epublcan one m oved ri eft, i ght. T hi caused the hi s stori l bi caly parti san support for scalrestrai to vani In nt sh. parti ar both the i vi s and groups cul , ndi dual w orki to l er taxes and those w orki ng ow ng to expand enti em ents w ere strengthened. tl T hese anti -tax and pro-spendi f ng orces j ned w i Presi oi th dent G eorge W . B ush to term i nate the stri budget rul of the ct es 1990s. T he resul w as a sw eled deci t l t. B ecause t here w as no l ongera requi ent rem that any spendi i ng ncrease or tax cut be pai for by a correspondi and deci d ng tneutralzi budget acti the gi tax i ng on, ant cut w ere notoset T he hard cap on nons . def ense dom esti di c screti onary spendi ng (w hi lm i ed i ch i t ncreases i such spendi n ng t the rate of i o nati al di on) so sappeared. T he consequences w ere predi ctabl e. Federalspendi grew at tw o and a hal ng f ti es the rate i di duri the 1 m t d ng 990s. Tw o l arge rounds of tax cuts substanti l realy duced the rati of federalrevenue to gdp. o T he overal budget shi l fted dram ati l caly, f rom a surpl representi one percentof us ng gdp i 1 to a deci equalto 3.2 percent n 998 t ofgdp i 2008. P ublc debtper capi rose n i ta by 50 percent,from $1 000 to m ore than 3, $1 000 overt s peri T he ei years of 9, hi od. ght the B ush adm i strati saw the l ni on argest scalerosi i A m eri hi on n can story. T hen,on top of thi the nanci and s, al econom i cri s struck i 2008,and the c si n U ni States confronted the possi lty ted bii of a 1930s-styl depressi W ashi e on. ngton correctl chose to enact a l y arge sti ul m us program and rescue totteri nanci ng al i tuti nsti ons. So far such e orts have , w orked,atl t t degree t a depreseast o he hat si w as averted. A recovery (al t one on bei that i hal ng and w eak by hi s ti stori cal standards) i under w ay. B ut the gap bes tw een spendi and revenues has w i ng dened m uch further R evenues,w hi had aver. ch aged 20 percent of gdp duri the 1990s, ng fel to nearl 1 percent,w hie spendi l y 5 l ng reached 25 percenti 2009. T he deci f n t or scalyear2009 hi a st t aggeri $1.6 t li ng rilon, or nearl 12 percent of a gdp of j over y ust $14 trilon. In nom i term s,i w as by li nal t far the l argest i U .S. hi n story. T he deci t

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A meri P roi and A meri Pow er can gacy can

for 2010,at $1. trilon and ni percent, 3 li ne w as nearl as huge. y T he m edi -term outl i poor T he um ook s . C ongressi onalB udget O ce forecasts $9. trilon ofcum ul ve deci through 5 li ati ts 2020 i other w ords,roughl $1 trilon n y li per year T he deci . t-to-gdp rati shoul o d decrease bri duri the m i e of thi ey ng ddl s peri as m odesteconom i grow th boosts od, c revenues.B ut as 2020 approaches,i w il t l ri agai back to nearl si percent,the se n, y x consequence ofsharpl hi y gher enti em ent tl costs and sl gdp grow th.P resi ow dent B arack O bam a ow n budget show s thi s s sam e trend the rstti e a U . presi m S. dent has ever proj ected deci thatgo back up. ts Federaldebt i the dolar-for-dolar s l l resul of deci and i has essenti l t ts, t al y tri ed over thi pastdecade,f pl s rom $3. tri5 l lon i 2000 (35 percentofgdp)t $9 t li i n o rilon i 2010 (62 percentofgdp).T he C ongresn si onalB udget O ce now sees i reachi t ng 90 percent by 2020.
THE BIGGEST BORROWER

It i i portant to understand the i pact sm m of al thi debt.A s i grow s,i l s t nterest rates i t y ri A s t do,t U . governnevi abl se. hey he S. m ent annuali s nterestexpense the costof borrow i m oney w ilri f ng l se rom one percentofgdp t f percentorm ore.A tt o our hat poi i nt, nterestexpense w oul ri def d val ense expendi tures.A nd i w oul exceed al t d l dom est c di i i scret onary spendi a cat ng, egory that i udes spendi on i ncl ng nfrastructure, educati energy,and agri ture i on, cul n eect anyt ng ot t ent tem ent and , hi her han i l s nat onalsecuri T he U . Treasury w oul i ty. S. d need t borrow a st o aggeri $5 t li every ng rilon si e year both to nance deci and to ngl , ts renance m aturi debt. ng Yetthe realoutl f deci and debt ook or ts i m uch w orse than these forecasts.For s

fore ign affairs . November / December 2010

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one thi the debtthatthe U ni States ng, ted e ecti y guarantees but that i not vel s i uded i o ci total i al ostequalto ncl n al ss m t Treasury D epart ent st ed $9 t li he m s at rilon t al In part cul ,t debtofgovernm ent ot . i ar he sponsored enterpri i another $8 trilon. ses s li T he bi ggest of these are the essenti l aly bankrupthousi nance agenci Fanni ng es, e M ae and Freddi M ac.T hey have been e pl aced i federalconservatorshi and nto p, for al practi purposes,thei debt i l cal r s equi ent to U . T reasury debt.T he val S. A m eri taxpayer stands fuly behi i can l nd t. State and l ocalgovernm ents al ow e so huge am ounts,on the order of $3 trilon. li A nd agai W ashi n, ngton i rectl stands ndi y behi m uch or al of i T hi sector i nd l t. s s deepl di y stressed,w i the l th argest state, C alforni recentl i ng ious.M orei a, y ssui over m any state and m uni palpensi , ci on system s use an anti quated pay-as-yougo fundi approach,w hi has l ng ch eft them underfunded by another $1 trilon. li T he post-2020 scaloutl i dow nook s ri apocal c,for tw o reasons.F i ght ypti rst, the agi ofthe U . popul on w ildri ng S. ati l ve sharp i ncreases i heal care costs (and n th at the sam e ti e,m ore A m eri m cans w ilbe l reti red).Second,federali nterest expense w ilri exponenti l as the T reasury l se aly, s borrow i costs grow w i the debt.T he ng th C ongressi onalB udgetO ce proj that ects o ci f al ederaldebt(excl ng governm ent udi sponsored ent erpri coul hi 11 percent ses) d t 0 of gdp by 2025 and 180 percent by 2035. A dj ng these f usti orecasts f the i tabl or nevi y sl er grow th that w oul accom pany ow d such qui y ri ng debt l s m eans ckl si evel hi ng those stratospheri rati sooner tti c os . W hy i thi scenari so dangerous? O ne s s o reason i that a l s arge am ount of federal borrow i w oul eat up the stock of ng d pri vate capi that i avaiabl to nance tal s l e

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i nvestm ent.A hi gher and hi gher percentage of personalsavi w oul be di ngs d verted to purchasi governm ent debt and aw ay ng f rom producti ty-enhanci i vi ng nvestm ents i equi entand technol n pm ogy.T hi w oul s d shri the base of producti capi and nk ve tal atten gdp and fam i y i l ncom es.A s m ore and m ore debt pi ed up,grow th w oul l d sl and A m eri ow cansstandard of l vi i ng w oul fal. d l In addi on,i ti nterest expense w oul d becom e so l arge as to crow d out w hol e categori of federalspendi B udgets es ng. for research,educati and i on, nfrastructure,to nam e but three exam pl w oul es, d i tabl declne i i nevi y i n nati on-adj usted t s.W ashi on capaci t respond t erm ngt s ty o o dom esti cri such as the recent recesc ses, si w oul al fade.A l of thi w oul on, d so l s d further underm i fam ii i ne les ncom es. A nother probl i the i em s nherent i nstabii associ lty ated w i the w orl s l th d argest econom y bei the w orl s bi ng d ggest borrow er T hi has t . s urned t gl he obaldynam i c of savi and borrow i on i head.For ngs ng ts decades,m ostdevel oped nati generated ons currentaccountsurpl uses,ornearsurpl uses, consi entw i h t rexportand i st t hei nvest ent m strength.T he poorer nati ons,for thei r part,ran deci as they i ported capi ts, m tal to nance devel opm ent. B ut today,the U ni States i the ted s bi ggest borrow er and devel ng nati , opi ons are i bi ts ggest l enders.T he data are i m perfect but suggest that the centralbanks of em ergi countri have been addi ng es ng betw een $700 bilon and $900 bilon to li li thei dolar portfolos i each of the past r l i n three years.M ost of these addi ons have ti taken the f orm ofU . T reasury securi es. S. ti In other w ords,these centralbanks are l endi to the U ni States.T he bi ng ted ggest l ender by far has been C hi na. Som e argue that the U ni States ted abii to borrow such vast am ounts i a lty s st rengt butt vi i m i ded.C hi h, hat ew s sgui na and the other l enders have no strategi c reason to conti hol ng U . dolars. nue di S. l A nd even though they w oul suer l d osses i ,for exam pl the dolar fel sharpl the f e, l l y, consequences of a m uch w eaker dolar l w oul be far w orse for the U ni States. d ted T he l onger W ashi ngton borrow s from these countri the greater the lkelhood es, i i that they w ilpurchase few er U . T real S. suri or even stop addi to thei hol ngs es ng r di of them al together A t that poi pre. nt, sum abl the term s of U . borrow i y, S. ng w oul becom e i d ncreasi y onerous, ngl causi a ri i i ng se n nterest rates and thus further sl i dow n the U . econom y. ow ng S. B ut i i preci y because thi scal ts sel s outl i so fri ook s ghteni that the very ng prospect of i coul tri t d gger acti that ons w oul i d nterrupt w hat i i trai T w o sn n. scenari are the m ostlkel T he desi e os i y. rabl one w oul i ve proacti i d nvol ve nterventi on by U . polti ans.R ealzi the dangers, S. i ci i ng O bam a and l eaders i C ongress w oul n d negoti a deci ate t-reducti package that on puls t count outofi s scalslde.Such l he ry t i an i nterventi happened i 1990 and on n agai i 1993 but on a m uch sm aler scal n n l e and i a l parti age. n ess san T hi ti e,polti ans coul take the s m i ci d i ti ve on thei ow n,or m ore lkel be ni ati r i y, pressed to do so by an unhappy el ectorate. R ecentpols i cat t publc di l ndi e hat i scont ent over deci and debt i sharpl ri ng, ts s y si but i i not cl that thi transl ts ear s ates i nto support for speci tax and spendi c ng changes.Indeed,the m agni tude of the tax i ncreases and spendi cuts requi ng red m akes such a vol untary dealunl kel i y. T hi j s udgm ent i onl underscored by the s y f thata su ci num ber ofD em ocrats act ent

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fore ign affairs . Volume 89 No. 6

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ERROR: typecheck OFFENDING COMMAND: .setglobal STACK: -mark-mark2 [/DeviceN [(Magenta)(Yellow)][/DeviceCMYK ]{-dictionary- --begin-- /_x1 xdf /_x0 xdf /_t0 _x0 --dup-- 1 --ge-- {--pop-- 1 }{--dup-- 0 --le-- {-pop-- 0 }{}--ifelse-- }--ifelse-- --def-- /_t1 _x1 --dup-- 1 --ge-- {-pop-- 1 }{--dup-- 0 --le-- {--pop-- 0 }{}--ifelse-- }--ifelse-- --def-/min0 _t0 --cvi-- --def-- /max0 _t0 --ceiling-- --cvi-- --def-- /min1 _t1 --cvi-- --def-- /max1 _t1 --ceiling-- --cvi-- --def-- /f0 min0 max0 --eq-- {{min0 f1 }}{{--mark-- min0 f1 max0 f1 0 1 3 {--dup-- 3 --index -- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t0 min0 max0 5 3 --roll-- int 3 1 --roll-- }--for-- --pop-- --pop-- --]-- }}--ifelse -- --def-- /f1 min1 max1 --eq-- {{/p0 xdf min1 f2 }}{{/p0 xdf --mark-min1 f2 max1 f2 0 1 3 {--dup-- 3 --index-- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t1 min1 max1 5 3 --roll-- int 3 1 --roll-- } --for-- --pop-- --pop-- --]-- }}--ifelse-- --def-- /f2 {/p1 xdf --mark -- 0 1 p1 lmt 2 --mul-- 0 1 p0 lmt --add-- 64 --mul-- 4 {--dup-- -3 -bitshift-- /byte-offset --exch-- def0 0 1 1 {byte-offset --add-- Sample --exch-- --get-- --exch-- 8 --bitshift-- --or-- }forexch 16 --add-- }-repeat-- --pop-- --]-- }--def-- /rnd {65536 --mul-- 0.5 --add-- --floor -- 65536 --div-- }--def-- f0 {}--forall-- --dup-- 65535 --ge-- {--pop-0 }{--dup-- 0 --le-- {--pop-- 0 }{--pop-- 0 }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 1 }{-dup-- 0 --le-- {--pop-- 0 }{65535 --div-- }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 1 }{--dup -- 0 --le-- {--pop-- 0 }{65535 --div-- }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 0 }{--dup-0 --le-- {--pop-- 0 }{--pop-- 0 }--ifelse-- }--ifelse-- 0 1 3 2 --roll -- lmt rnd 4 1 --roll-- --end-- }] [/DeviceN [(Magenta)(Yellow)][/DeviceCMYK ]{-dictionary- --begin-- /_x1 xdf /_x0 xdf /_t0 _x0 --dup-- 1 --ge-- {--pop-- 1 }{--dup-- 0 --le-- {-pop-- 0 }{}--ifelse-- }--ifelse-- --def-- /_t1 _x1 --dup-- 1 --ge-- {-pop-- 1 }{--dup-- 0 --le-- {--pop-- 0 }{}--ifelse-- }--ifelse-- --def-/min0 _t0 --cvi-- --def-- /max0 _t0 --ceiling-- --cvi-- --def-- /min1 _t1 --cvi-- --def-- /max1 _t1 --ceiling-- --cvi-- --def-- /f0 min0 max0 --eq-- {{min0 f1 }}{{--mark-- min0 f1 max0 f1 0 1 3 {--dup-- 3 --index -- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t0 min0 max0 5 3 --roll-- int 3 1 --roll-- }--for-- --pop-- --pop-- --]-- }}--ifelse -- --def-- /f1 min1 max1 --eq-- {{/p0 xdf min1 f2 }}{{/p0 xdf --mark-min1 f2 max1 f2 0 1 3 {--dup-- 3 --index-- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t1 min1 max1 5 3 --roll-- int 3 1 --roll-- } --for-- --pop-- --pop-- --]-- }}--ifelse-- --def-- /f2 {/p1 xdf --mark -- 0 1 p1 lmt 2 --mul-- 0 1 p0 lmt --add-- 64 --mul-- 4 {--dup-- -3 -bitshift-- /byte-offset --exch-- def0 0 1 1 {byte-offset --add-- Sample --exch-- --get-- --exch-- 8 --bitshift-- --or-- }forexch 16 --add-- }-repeat-- --pop-- --]-- }--def-- /rnd {65536 --mul-- 0.5 --add-- --floor -- 65536 --div-- }--def-- f0 {}--forall-- --dup-- 65535 --ge-- {--pop-0 }{--dup-- 0 --le-- {--pop-- 0 }{--pop-- 0 }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 1 }{-dup-- 0 --le-- {--pop-- 0 }{65535 --div-- }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 1 }{--dup -- 0 --le-- {--pop-- 0 }{65535 --div-- }--ifelse-- }--ifelse-- 0 1 3 2 --roll-- lmt rnd 4 1 --roll-- --dup-- 65535 --ge-- {--pop-- 0 }{--dup-0 --le-- {--pop-- 0 }{--pop-- 0 }--ifelse-- }--ifelse-- 0 1 3 2 --roll -- lmt rnd 4 1 --roll-- --end-- }] [/DeviceN [(Magenta)(Yellow)][/DeviceCMYK ]{-dictionary- --begin-- /_x1 xdf /_x0 xdf /_t0 _x0 --dup-- 1 --ge-- {--pop-- 1 }{--dup-- 0 --le-- {-pop-- 0 }{}--ifelse-- }--ifelse-- --def-- /_t1 _x1 --dup-- 1 --ge-- {-pop-- 1 }{--dup-- 0 --le-- {--pop-- 0 }{}--ifelse-- }--ifelse-- --def-/min0 _t0 --cvi-- --def-- /max0 _t0 --ceiling-- --cvi-- --def-- /min1 _t1 --cvi-- --def-- /max1 _t1 --ceiling-- --cvi-- --def-- /f0 min0 max0 --eq-- {{min0 f1 }}{{--mark-- min0 f1 max0 f1 0 1 3 {--dup-- 3 --index -- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t0 min0 max0 5 3 --roll-- int 3 1 --roll-- }--for-- --pop-- --pop-- --]-- }}--ifelse -- --def-- /f1 min1 max1 --eq-- {{/p0 xdf min1 f2 }}{{/p0 xdf --mark-min1 f2 max1 f2 0 1 3 {--dup-- 3 --index-- --exch-- --get-- --exch-- 2 --index-- --exch-- --get-- _t1 min1 max1 5 3 --roll-- int 3 1 --roll-- }