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Indebted America Risks an Age of Austerity

Authors: Roger C. Altman, Chairman, Evercore Partners, Inc., and Richard N. Haass, President, Council on Foreign Relations
January 23, 2011
Financial Times

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His Tucson speech on civility revealed President Barack Obama at his best: as moral leader and educator. Now comes an even bigger moment, the State of the Union address. Although the speech will almost certainly focus on steps to accelerate growth and improve troubled labour markets, the president would be wise to discuss what is ultimately the greatest threat to America's economic well-being and its role in the world – its deteriorating and unsustainable fiscal condition.

It will be tempting for Mr Obama to describe this threat in the most general terms, acknowledge the urgency of solving it and leave it there. After all, he appointed a budget commission last year and, so far, has been mostly silent on its recommendations. But the country needs him to break that silence and educate Americans on the sacrifices that are inevitable and on the spending cuts and tax increases that cannot be avoided if a far worse crisis is to be averted.

This is the right moment because, for all the commentary on deficits and debt, the danger is greater than most Americans understand. Not even the US can indefinitely run up debt at the current, astronomical rate. If our leaders do not rein it in, global financial markets will ultimately force a solution. In other words, adjustment will either be done by the US or to it. The latter scenario would mean ugly bud­get changes: larger than necessary, indiscriminate and imposed virtually overnight. No one can predict when markets might move on America, but it is a question of when, not if.

The result would be an age of American austerity. No category of federal spending, from defence to Medicare, would be spared. Taxes on most or all individuals and businesses would rise. Economic growth would slow. The consequences for America's international role, and for world stability, would be profoundly negative.

America's debt is piling up at a rate not seen, outside of the second world war, since record-keeping began in 1792. Federal debt has nearly tripled in the past 10 years, from $3,500bn to more than $9,000bn. The ratio of debt to gross domestic product has doubled. Federal debt, of course, is the dollar-for-dollar product of deficits. Each of the past three years has seen trillion-dollar deficits, each larger in both absolute and proportionate terms than ever recorded before 2008.

Unfortunately, this picture gets worse. The Congressional Budget Office projects that the debt to GDP ratio will hit 90 per cent by 2020; the International Monetary Fund projects that it will reach 115 per cent. These are levels usually associated with Italy or Greece. The US will reach them within nine years.

The American economy is strengthening, and that will improve federal revenue. The annual deficit will narrow to 4-5 per cent of GDP – still very large – by mid-decade. But it will then widen again as the growing elderly population drives up medical costs. New tax cuts, along with the extension of old ones approved in the recent lame-duck congressional session, will only make matters worse.

It is important to understand the impact of this debt path and why global financial markets will reject it if America's leaders do not. Should federal debt reach 90 per cent of GDP by 2020, interest expense would exceed all domestic discretionary spending – more than the sum of education, energy, infrastructure and agriculture spending. Indeed, it would rival what is spent on defence. The US Treasury would be borrowing roughly $5,000bn each year. None of these comparisons includes another $9,000bn of debt (which is guaranteed by the US government) or the gigantic obligations of government-backed mortgage financiers Fannie Mae and Freddie Mac (which are de facto guaranteed).

Those who claim the debt crises that have struck Greece and Ireland recently and so many others cannot hit America should study the events of 1979. That was the period of stagflation, the Iranian oil embargo and President Jimmy Carter. The US dollar had been weakening for months but, when Mr Carter proposed a larger than expected budget deficit, markets revolted. The dollar plunged, global markets fell and an international rescue of the dollar was required. Within days, the US was forced to halve its budget deficit and the Federal Reserve had to raise rates sharply. America was not immune from global financial rejection then, and it is not now.

A negotiated agreement between the president and congressional leadership is the right approach. The scale of deficit reduction needed to stabilise the US debt to GDP ratio, however, is large – between $200bn and $300bn annually. That means reducing entitlements and discretionary spending (anathema to congressional Democrats) as well as defence cuts and higher taxes (seen as toxic by Republicans). Bridging those differences promises to be a Himalayan task and is unlikely today. Only Mr Obama can begin to change this dynamic.

It is important that he does so, not only for the US but also for the world. For the onset of true austerity would shrink America's global role. Security spending would fall, as would foreign aid. No one else is able to pick up the slack. The result would be a messier world, one less prosperous, less safe and less free. Those who see US global activism as something to be indiscriminately reined in should think twice lest they get what they wish for.

Roger Altman is chairman of Evercore Partners and was deputy US Treasury secretary, 1993-94. Richard Haass is president of the council on foreign relations and was director of policy planning at the US state department, 2001-03

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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