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This run-up in debt represents the most rapid, predatory looting of public wealth in the history of the world. The interest costs alone will consume the government and, soon, the entire economy. In fiscal 2004, interest costs came to $321 billion against a deficit of $415 billion. So three quarters of all the current year borrowing is spent paying interest on past borrowing. This is the most immediate symptom of the deficit death spiral.
And the situation will only get worse when interest rates rise, as they must. The U.S. has enjoyed an unprecedented period of low rates, the lowest in 50 years. The only direction they can go is up. And they will rise quickly once foreigners, who are more and more the buyers of U.S. debt, become saturated with dollars and begin to eschew additional lending.
This is effectively what happened in the early 1970s when the Arab oil sheikdoms realized that Nixon had decoupled the dollar from gold redemption but was still paying for oil in dollars--essentially paper. The sheiks tripled the price of oil in 1973 and again in 1978. The OPEC "oil shocks" wrought havoc on the American economy, putting a death to the halcyon days of post-World War II economic growth. Today's oil at $50 a barrel is the modern day enactment of the same implicit disdain for dollars.
The Japanese did the same thing in 1987. For years they had funded Reagan's massive supply side budget deficits but had been made fools as the dollar was losing 15% a year in value, more than wiping out the 5% return they were receiving on their treasuries. They wisely stopped buying in October 1987, precipitating the greatest one-day U.S. stock market collapse since the Great Depression.
The "dollar overhang" problem caused by Bush's record budget deficits is compounded by record U.S. trade deficits. Every month, the U.S. economy buys some $50 billion more from the world than it sells, in the act flooding the world with private dollars. These are on top of the public dollars from the budget deficits. The total trade deficit for 2004 will amount to some $680 billion. As recently as 1992, the amount was only $34 billion, a twenty fold increase in just over 10 years, another sign of the spiral.
These "twin deficits"--trade and budget--combine to well over $1 trillion a year of borrowing. Their effect is to bury the world's economy in dollar debts, dollars that increasingly buy less and less. As mentioned above, no one knows when the world will say, "enough." Japan holds a reported $1 trillion supply of dollars, China, more than half a trillion. Both have bought dollars--in effect loaning equivalent sums to the U.S.--in order to keep the value of their own currencies low and therefore make their own goods cheaper in American markets.
The Bush administration claims that both countries will continue to buy dollars so that their own currencies will not rise. But the danger is that once one major player declares it doesn't want any more dollars there will be a rush for the exits. Demand for dollars, and with it, the dollar's price, will plummet. The last player holding dollars will be stuck with the bag, a multi-trillion dollar stash of dollar holdings that are worth only a fraction of what they were just a month before.
In other words, there are structural incentives biasing the descent toward chaos rather than order. Already, the dollar is down 19% over the past year, an eerie harkening of the Japanese experience of the late eighties. Its decline is being cagily "managed" by the U.S. Treasury which has muscled foreign central banks into picking up the slack since private foreign buyers have begun to refuse further dollar purchases. Foreign central banks now hold some 40% of total U.S. government debt.
The only way the U.S. government can prevent a stampede is to raise interest rates--the return for holding dollars. And Alan Greenspan has begun this process. But this, of course, increases the carrying costs of the national debt. As if a $7 trillion national debt funded at 4% isn't bad enough, envision a $15 trillion debt at 10%. Instead of $300 billion a year in interest costs, think of $1.5 trillion. Instead of interest amounting to 3% of GDP, imagine the carnage as it approaches 10%.
The higher rates will put a knife in the heart of an already tenuous recovery, undermining the only process by which payoff might ever be accomplished. It will suck all of the oxygen out of the economy. Economists call this the "crowding out effect" when lending to the government gets priority over private lending. After all, government has the power to tax in order to fulfill its obligations whereas private borrowers do not.
But the market rations shortages by raising prices--interest rates--forcing private borrowers to pay ever more for scarce capital. In this way, markets for private debt mirror markets for public debt. Investment, the foundation of future growth, will be savaged. New roads, hospitals, factories, schools and research will be sacrificed to escalating interest rates borne of stratospheric debt.
This occurred during the deficit-burdened 1980's when investment grew at an annual rate of only 2.5% versus 6.9% in the surplus-graced 1990's. And not surprisingly, productivity suffered as well. It grew at a meager 1.4% per year dur
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