The Indebted States of America

America has already exceeded its statutory debt ceiling. If Congress fails to increase the limit immediately, a financial crisis worse than that of 2008 can begin.

Can America go bankrupt? Bankruptcy is when someone is no longer able to pay off his debts, and others don’t want to lend to him anymore. America can still find those who are willing to lend her money, but the increasing debt can result in consequences which are hard to imagine. It is not the amount of debt that is problem here as it is still lower than America’s GDP. Japanese debt is twice as high as its GDP, but no one has to worry about insolvency or the consequences of such debt for the currency. Quite to the contrary, the Japanese are concerned about the yen being so strong. America doesn’t have any problems with debt service. It is not Greece, which has to pay 20 percent interest on its three-year bonds. The American government has to pay 3 percent on its 10-year bonds.

The entire debt consists of two parts. The first and larger one is the so-called public debt: obligations toward private persons and companies in the U.S. and abroad as well as toward central banks of other countries. The second and smaller part is the American government’s investment in its own bonds, which mostly refers to the Social Security system; according to law, Social Security savings have to be invested in interest-bearing Treasury bonds. From the accounting point of view, both are the same kind of debt, so it is aggregated and the amount resulting from it has already exceeded the statutory limit of $14.294 billion. Either Congress increases the limit by August 2, or there will be cuts in spending: The scary vision of suspending pensions or salary payments for the military is already out there.

It is not even the amount of American debt that is scary, but its pace of growth. And it is all because America has created an immense budget deficit in the last 10 years, and it is becoming more difficult to keep it under control. In 2000, during Clinton’s presidency, there was a budget surplus exceeding $230 billion. The economists racked their brains thinking how to deal with a $2 trillion surplus that was already appearing in the horizon, but two expensive wars, two recessions, tax cuts and generous medication refunds for senior citizens turned the surplus into an immense deficit of more than $14 trillion.

How to deal with such a deficit is the subject of a great battle between the President and the Republicans. In addition, there is the tea party (an American conservative-libertarian social movement) making some noise in the background, thus making the show more attractive but making the search for a compromise more complicated. The deficit is to exceed $1.6 trillion this year, and it won’t disappear soon. And each deficit adds to the debt already existing.

There is not much time left. There are two heavy vehicles running toward each other on the same lane. If neither of them decides to pull away, a deadly collision will happen. Who gives up first? In America, it is called a chicken game, but in this case the chicken is not poultry, but a coward, the one who gives in first. The Democratic-Republican wrestling over the debt ceiling resembles that game today.

The President and the Democrats say: Let’s cut spending but not blindly, so we cut fat and not meat. Also, let’s have a look at possibilities of increasing revenue, which is on the ground asking to be picked via increased taxes for the wealthiest and for some privileged corporations. The Republicans say: Cut as it goes and forget about any tax increase. Without a compromise, the country may experience something that has never happened in its history before.

Professor Austan Goolsbee, until recently the chairman of the president’s Council of Economic Advisers, said that if the worst scenario comes true and Congress doesn’t raise the debt ceiling, the consequences will be worse than that of the 2008 financial crisis. Timothy Geithner, the Secretary of Treasury, keeps talking about long-term and far-reaching negative consequences of such a scenario. These warnings are echoed by Ben Bernanke, the head of the Federal Reserve. The credit rating agencies keep warning as well. Others, however, know better.

The terrifying ignorance of some of so-called political elites appears. One wonders if the representatives of the tea party are aware of the fact that the country’s entire revenue this year ($2.173 trillion) is not enough to cover the government’s spending on pensions, healthcare and benefits for the disabled and the poor (which cost $2.238 trillion). Even if the government doesn’t spend a single cent on the army, border patrols, air traffic controllers, roads, trains, bridges, teachers, etc. (not to mention aid for other countries), it will still need to borrow. If it is Michelle Bachman, the new tea party star and a presidential candidate, saying that there is no need to raise the ceiling as there is enough for the Treasury to pay interest, you can blame it on a lack of experience. But if it is Senator Jim DeMint saying such bull, that is really something else.

The situation is oscillating between absurd and catastrophic.

Those who are terrified with the amount of debt are against raising the tax rate for families earning more than $250,000 from 35 to 39.5 percent as stipulated by the law revoked during George W. Bush’s presidency. They claim it will kill incentives for entrepreneurship even though from WWII until 1980, the highest income tax rate did not go lower than 70 percent, and from 1954 to 1963, which were not bad years for America, it amounted to 91 percent. Still, it didn’t discourage the rich and resourceful from investing.

President Reagan lowered this rate down to 50 percent and even to 28 percent by the end of his term in office. He almost tripled the U.S. debt. When he was moved into the White House, America’s public debt was $909 billion. When he was moving out, it reached 2.6 trillion! His successor, George H. W. Bush, raised taxes despite promises made, which made him lose the elections that followed.

Political Suicide

The American political system, more and more dependent on big money and vulnerable to the influence of interest groups, is dealing with America’s problems very poorly. Last months’ example: Oil companies reached record profits, and it seemed to be a good moment to eliminate their tax privileges especially when facing such an immense deficit. Only a few votes were missing in the Senate to cut $21 billion in subsidies in the following 10 years.

A quick and radical improvement is impossible because of the deficit’s structural character: Almost 60 percent of all governmental spending goes to Social Security (disability compensation and pensions), Medicaid (healthcare scheme for the poorest) and Medicare (healthcare program for disabled and retired). They run on autopilot, pushing the entire system toward bankruptcy. The deficit cannot be stopped or even slowed down without pension scheme changes and revolutionary changes in healthcare for the retired. The largest generation of baby boomers (between 1946 and 1964) is just starting to retire. It will only increase the pressure on pensions and healthcare for those people.

When the currently existing government pension scheme, Social Security, was created, there were 42 Americans of productive age for every retiree, and the average lifespan was 60 years for men and 64 for women. Now, there are three working for every retiree, and if the retirement age doesn’t change there will just a bit more than two by 2040. Even though the average lifespan is longer now at 78 years, people are retiring at a much younger age.

Declarations to raise taxes for the middle class are political suicide. Increasing taxes for the only the rich will not cover the hole in the budget. A true healing of finances will not miss social benefits, and such vision is rather unattractive to anyone except for Republican think tanks. Even 70 percent of radical tea party supporters are against any cuts in Medicare and Medicaid.

It is mainly due to the immense budget and balance of trade deficit, as well as the lack of a realistic vision for healing, that the dollar is losing its value. When America’s dollar weakens, China and Japan keep supporting it to support their own export. Those are the countries which buy U.S. Treasury bonds, thus allowing the government to go deeper in debt. Last year, 53 percent of America’s debt was in American hands, and Chinese and Japanese central banks and their private investors held 20 percent of American debt.

To significantly improve the dollar’s condition, an improvements in America’s budget and balance of trade or interest rate increases that would make American bonds more attractive are needed. None of the above seem to be possible. One day, the dollar will surely find its competitors as a reserve currency, but it will not lose its position until some trustworthy alternative is there. The euro was supposed to be one of them, but it has its own problems to deal with now.

Even though the economy is limping, Wall Street is doing quite well as the interests of an average American worker and the market are no longer the same. When Americans lose their jobs, it is often because of domestic companies moving into less expensive areas to make more money. The stock exchange is interested in profits and not in jobs.

If political compromises, currently unimaginable, do not allow for significant spending cuts, tax increases will be the only way to cover the hole, and it is a fundamental sin for the Republicans. Military spending is now $476 billion higher than during the times of Clinton. Social Security spending is higher by $340 billion and Medicare by $297 billion. Meanwhile, last year, both personal and corporate taxes were lower than 10 years ago. Republicans defend the military budget fiercely even when the Pentagon is willing to cut it. None of the parties wants pension scheme reform even though it is inevitable; otherwise, in 30 years, there will be no money left. The main candidates for cuts are: health, education and Social Security.

There are suggested prescriptions, such as taking advantage of the good gold market and reaching for the $370 billion worth of national reserves in Fort Knox, that would have been taken as a bad joke some time ago. This would only put the problem off for a few months because the government needs to borrow $125 billion every month to fulfill its obligations. Others keep reminding that the government owns 650 million acres (more than 263 million hectares) of land and a million buildings, not to mention the highways, so why not sell parts of them? The enforcement of such ideas would surely be considered as an act of despair. As soon as the investors start losing their sleep worrying about America’s solvency, they are going to demand higher interests on U.S. Treasury bonds. And today, there is the tea party existing in Congress, so nothing can be excluded 100 percent.

The Republicans want to use the debt ceiling crisis to force Obama to approve significant spending cuts. President Obama (five years ago, still as a Senator) voted against increasing the ceiling without a deficit reduction plan. Now, he knows how it tastes.

The debt ceiling must be and will be raised, however. The question remains when, how and by how much. As to when, the answer must be “before August 2.” The debt is doomed to grow in the following decade. The public debt (let us not forget that it is only a part of the whole) will amount to $10.4 trillion this year, and it is supposed to reach $18.3 trillion in 10 years. The mentioned amounts are immense and terrifying, and all estimates based on quite optimistic assumptions of quick economic growth and of an unemployment rate that is supposed to drop below 6 percent in a few years and remains at that level. They also assume that there will be 45,000 American soldiers abroad, not 215,000 like right now. So, if the debt ceiling is not increased in a significant way or is not fixed in relation to the GDP, similar games will take place in the USA on a regular basis. The most important question therefore is: How? The answer will be more political than economic.