While the global financial system remains transfixed by the problems of Greece and several other European countries risking default over their massive debts, the real threat is whether the credit standing and currency stability of the world’s biggest borrower, the United States, will be jeopardized by its disastrous outlook on deficits and debt.
That’s the fear raised in a devastating op-ed on the Financial Times website written by Roger Altman, a former deputy U.S. Treasury secretary under President Clinton who is now chairman of Evercore Partner, a leading global advisory and investment firm.
“America’s fiscal picture is even worse than it looks,” Altman writes. “The non-partisan Congressional Budget Office just projected that over 10 years, cumulative deficits will reach $9.7 trillion and federal debt 90 percent of gross domestic product – nearly equal to Italy’s.
“Global capital markets are unlikely to accept that credit erosion,” Altman says. “If they revolt, as in 1979, ugly changes in fiscal and monetary policy will be imposed on Washington. More than Afghanistan or unemployment, this is President Barack Obama’s greatest vulnerability.”
The financial outlook for the United States is frightening. The size of the federal debt is projected by the CBO to increase by nearly 250 percent over 10 years, from $7.5 trillion to a whopping $20 trillion.
The only remote comparison to such a debt load in the World War II, a global conflict that killed 50 million people, Altman and other analysts have written.
But there is no real comparison even in the 1940s and 50s for such a rise in indebtedness – nothing remotely like it has occurred since record keeping began in 1792, Altman writes.
“It is so rapid that, by 2020, the Treasury may borrow about $5 trillion per year to refinance maturing debt and raise new money; annual interest payments on those borrowings will exceed all domestic discretionary spending and rival the defense budget,” Altman writes in the Financial Times.
“Unfortunately, the health care bill has little positive budget impact in this period," he writes.
“Why is this outlook dangerous? Because dollar interest rates would be so high as to choke private investment and global growth,” Altman points out.
Altman makes clear that the current mess is not entirely Obama’s doing. But the massive spending programs being proffered by his administration has taken a potential catastrophe in the making and made it much worse.
The severe fiscal decline over the last year reflects a continuation of the Bush deficits and the lower revenue and countercyclical spending triggered by the recession. Obama’s own initiatives are responsible for only 15 percent of the deterioration.
But Obama now owns this crisis. The economy is simply too weak right now to handle a severe deficit reduction plan, Altman says. And the budget commission Obama has appointed to study deficit reduction will not report until December, meaning much of 2011 could by consumed by further debate with little tough action.
But Alman says the solution is clear to everyone. “The deficit/GDP ratio must be reduced by at least 2 percent, or about $300 billion in annual spending. It must include large spending cuts, such as to entitlements, and new revenue.
But Altman says it must also come from higher taxes on income, capital gains and dividends or a new tax, such as a progressive value added tax, or VAT.
But that will be clearly anathema to fiscal conservatives, especially in the wake of the enactment of the largest piece of social spending legislation in the last half century, the Obama healthcare law.
But to do nothing is unthinkable, Altman writes. “The second possible course is the opposite: government paralysis and 10 years of fiscal erosion. Debt reaches 90 per cent of GDP. Interest rates go much higher, but the world’s capital markets finance these needs without serious instability.
“History suggests a third outcome is the likely one: one imposed by global markets. Yes, there may be calm in currency and credit markets over the next year or two. But the chances that they would accept such a long-term fiscal slide are low. Here, the 1979 dollar crash is instructive. The Iranian oil embargo, stagflation and a weakening dollar were roiling markets. Amid this nervousness, President Jimmy Carter submitted his budget, incorporating a larger than expected deficit.”
That triggered a plunge in the dollar that destabilized markets, forcing Carter to resubmit a tighter budget and the Fed to raise interest rates. Both actions harmed the economy and severely injured his presidency.
“America’s addiction to debt poses a similar threat now,” Altman concludes.
“To avoid an imposed and ugly solution,Obama will have to invest all his political capital in a budget agreement next year. He will be advised that cutting spending and raising taxes is too risky for his 2012 re-election. But the alternative could be much worse.”
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