Austrian School economists and analysts who have warned that we are facing a Federal debt cataclysm have now received grudging confirmation from a most unlikely source: the Council on Foreign Relations.
The Council on Foreign Relations is the single most influential discussion forum in the United States. Its quarterly journal, Foreign Affairs, is therefore the most influential publication in the country and therefore the world.
This is not to say that every article is influential. Most of them are not. They are often written by academic specialists in narrow fields. Their opinions are rarely translated into government policy. Equally rare is any Foreign Affairs article that winds up being quoted five years later. The journal is a kind of sounding board. The relative handful of key decision-makers in the organization want access to what “the best and the brightest” are thinking. This includes lots of academic busy-bees who are trying to break into the CFR’s inner circle. The decision-makers are never sure who has the best insight on the future, so the editor publishes lots of articles that sink without a trace.
Nevertheless, once in a while, one of these articles does become the basis of long-term government policy. Such was the case with the 1947 article by George Kennan, who published anonymously as “X.” It set forth the entire post-War policy of containment of the Soviet Union. So, it pays for columnists and analysts and investors to be aware of what the latest issue of Foreign Affairs has to say.
A TURNING-POINT ARTICLE
The November/December issue features an article that I think will become a turning point. A decade from now, or a quarter century from now, historians will return to it and summarize its contents. It will be regarded as the first official announcement in the highest of high places that the Federal deficit is out of control, and that this in turn threatens the survival of America’s position as the world’s most influential political-military participant.
The article is titled, “American Profligacy and American Power: The Consequences of Fiscal Irresponsibility.” I have been reading Foreign Affairs for about four decades, but I do not recall any article with a title this inflammatory.
It is co-authored by Richard Haass and Roger Altman. Haass has been the president of the CFR since 2003. He was trained as a philosopher. He received his doctorate from Oxford. He was a Rhodes scholar. In short, he is a true representative of the Anglo-American Establishment, as described by Georgetown University Professor Carroll Quigley’s book of the same title.It is free here.
Haass has been a high-level policy-maker and advisor for two decades. This is from his Wikipedia biography.
Haass was Special Assistant to United States President George H. W. Bush and National Security Council Senior Director for Near East and South Asian Affairs. In 1991, Haass received the Presidential Citizens Medal for helping to develop and explain U.S. policy during Operation Desert Shield and Operation Desert Storm. Previously, he served in various posts in the Department of State (1981-85) and the Department of Defense (1979-80) and was a legislative aide in the U.S. Senate.
Haass’s other postings include Vice President and Director of Foreign Policy Studies at the Brookings Institution, the Sol M. Linowitz Visiting Professor of International Studies at Hamilton College, a senior associate at the Carnegie Endowment for International Peace.
I list all this to indicate that he has the bona fides, or in another context, he has made his bones. When he writes an article in “Foreign Affairs,” anyone who wants to get a sense of what the latest thinking is in high places would be wise to pay very close attention.
His co-author comes from the investment-banking/hedge-fund world. Citing his Wikipedia entry,
He was a general partner of Lehman Brothers from 1974 to 1977. From 1977 to 1981 he served as the Assistant Secretary of the United States Department of the Treasury, during which time he helped oversee the then-troubled financial affairs of Chrysler. In 1981, he returned to Lehman Brothers, where he became the co-head of investment banking and served on the board of the company and the management committee. During the 1980s, he was a lecturer and adjunct professor at the Yale School of Management. In 1987, Altman joined the newly-formed Blackstone Group as vice-chairman, head of its mergers and acquisitions advisory business and a member of the investment committee. . . .
Altman has served as advisor to two presidential candidates: John Kerry in 2004, and Hillary Clinton in 2008.
When these two men jointly publish an article on what the United States is facing, we can be sure that this opinion is well within the boundaries of acceptable discourse at the top of the American Establishment. I will go even further. The article was designed to establish the starting point for discussion. This article, in short, is ground zero.
CONFIRMING NIALL FERGUSON
Niall Ferguson is the senior academic representative of the Anglo-American Establishment. He holds an endowed chair in international affairs at the London School of Economics. He also holds endowed chairs at Harvard University and the Harvard Business School. I can think of no one else in my lifetime who matched his simultaneous endowments, in every sense.
Additionally, he is well known to the American literati for his PBS series on The Ascent of Money, which was much better than PBS deserved. He is all of 46-years-old, which is academic uppitiness on an unprecedented scale in the humanities.
For three years, he has been issuing a series of warnings in the form of historical comparisons and predictions. His most graphic historical comparison is the Ottoman Empire after 1870. Here is his assessment.
Yet, on closer inspection, we are indeed living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US. In the aftermath of the Crimean war, both the sultan in Constantinople and his Egyptian vassal, the khedive, had begun to accumulate huge domestic and foreign debts. . . .
The loans had been made for both military and economic reasons: to support the Ottoman military position during and after the Crimean war and to finance railway and canal construction, including the building of the Suez canal, which had opened in 1869. . . . In October 1875 the Ottoman government declared bankruptcy. . . .
His concluding words are no doubt what caught the attention of the senior members of the CFR.
It remains to be seen how quickly today’s financial shift will be followed by a comparable geopolitical shift in favour of the new export and energy empires of the east. Suffice to say that the historical analogy does not bode well for America’s quasi-imperial network of bases and allies across the Middle East and Asia. Debtor empires sooner or later have to do more than just sell shares to satisfy their creditors.
The article begins with a statement that would not have been taken seriously in academic or policy-making circles as recently as three years ago. I will be quoting extensively from this article, because there are readers out there who would otherwise say, “you are exaggerating. No one at the CFR would say such things publicly.” They did say them, and I have no need to exaggerate.
The U.S. government is incurring debt at a historically unprecedented and ultimately unsustainable rate. The Congressional Budget Office 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) staff 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 (p. 25).
The key word is “unsustainable.” The authors go on to say that current interest rates are low, but “this calm will not last.”
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 fiscal policy.
Here, in the refined and august pages of “Foreign Affairs,” the head of the CFR has used the phrase “debt addiction.” This is right out of the hard-money newsletter camp. So is the conclusion.
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 suffer. 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.
So far, this is the soft-core stuff. The next section spells it out in no uncertain terms.
“THE ROAD TO RUIN”
Yes, this is their section header. They begin by pointing out that, 12 years ago, the Federal debt was 35% of GDP. The country had no tradition of massive Federal debt, except during World War II. This ended with the Presidency of George W. Bush and the bipartisan overturning of a tradition of fiscal restraint. It was a combination of anti-tax sentiment and pro-entitlement spending.
Federal spending grew at two and a half times the rate it did during the 1990s. . . . Public debt per capita rose by 50 percent, from $13,000 to more than $19,000 over this period. The eight years of the Bush administration saw the largest fiscal erosion in American history (p. 26).
This is an accurate assessment. Austrian School analysts have been crying in the wilderness for nine years, warning that this would happen. The CFR and the Establishment media did not give an advanced warning. Now, what we predicted has happened.
Then came the recession of 2007â€“9, which Austrians also warned was coming as early as 2006. We were dismissed as crackpots.
Revenues, which had averaged 20 percent of GDP during the 1990s, fell to nearly 15 percent, while spending reached 25 percent in 2009. The deficit for fiscal year 2009 hit a staggering $1.6 trillion, or nearly 12 percent of a GDP of just over $14 trillion. In nominal terms, it was by far the largest in U.S. history. The deficit for 2010, at $1.3 trillion and nine percent, was nearly as huge (pp. 26â€“27).
That is the story of the deficits. What is the story of the total on-budget debt?
Federal debt is the dollar-for-dollar result of deficits, and it has essentially tripled over this past decade, from $3.5 trillion in 2000 (35 percent of GDP) to $9 trillion in 2010 (62 percent of GDP). The Congressional Budget Office now sees it reaching 90 percent by 2020.
These are staggering numbers. Of course, the unfunded Medicare and Social Security obligations dwarf the on-budget debt.
Interest rates will rise. The authors say that interest expenses will equal the entire Defense Department budget by 2020. In 2020, the Treasury will have to borrow $5 trillion a year to roll over the debt. Don’t forget the Treasury’s obligation to Fannie Mae and Freddie Mac. The debt of government-sponsored enterprises is already $8 trillion. State and local debt totals $3 trillion. They say that Washington indirectly stands behind all of this. (They mean politically, not legally.) Add to this unfunded state and municipal pension obligations of $1 trillion. All this will get much worse after 2020.
The post-2020 fiscal outlook is downright apocalyptic, for two reasons. First, the aging of the U.S. population will drive sharp increases in health care costs (and at the same time, more Americans will be retired). Second, federal interest expense will rise exponentially, as the Treasury’s borrowing costs grow with the debt.
What is the threat? The Austrian School’s famous â€“ and always previously denied â€“ crowding-out effect.
Why is this scenario so dangerous? One reason is that a large amount of federal borrowing would eat up the stock of private capital that is available to finance investment. A higher and higher percentage of personal savings would be diverted to purchasing government debt and away from productivity-enhancing investments in equipment and technology. This would shrink the base of productive capital and flatten gdp and family incomes. As more and more debt piled up, growth would slow and Americans’ standard of living would fall.
Notice, they do not say that the standard of living will cease to increase as fast. They say that it will fall.
China and foreign central banks will not continue to support this increase of debt. Interest rates will rise. The present safe-haven status of T-bonds will disappear, they say.
Then will come the spending cuts. Everything will be cut: defense, social spending, and even Medicare and Social Security.
They see what will happen to defense spending. The war in Afghanistan is now twice as expensive as the war in Iraq (p. 31). They do not think that the promised troop draw-downs will be anything more than token. This is costing $100 billion a year. This will not be repeated.
Nation building is a time-consuming, labor-intensive, and expensive exercise, and for these and other reasons, it is unlikely to be repeated on a scale approximating that of Iraq or Afghanistan for the foreseeable future. This does not mean that there will not be wars of choice â€“ a conflict with Iran is a possibility given its nuclear ambitions â€“ but rather that such wars will be both less common and more limited in their aims (p. 33).
Side note: Why do they imagine that a war with Iran would not result in expenses rivaling those of the Iraq war? It would not be nation-building, but it would be very expensive. Inciting the Shia paramilitary forces in Iraq would not be nation-building. Sadr City would extend its boundaries fast.
They call for a balanced budget, other than interest expenses, by 2015.
That, however, will require reducing Washington’s budget deficits by approximately $300 billion a year â€“ a large amount by any standard (p. 33).
Wait a minute. They call for a piddly deficit reduction of $300 billion a year, when the CBO projects deficits of $1 trillion a year out to 2020. The CBO prudently refuses to say what will happen after 2020. There is a serious statistical disconnect here.
They add: “But the politics are difficult.” Difficult as in “running the hundred-meter dash in six seconds flat.”
What is to be done? Those old favorites: cut spending and raise taxes. What is the chance of that?
The bottom line is that it will be extraordinarily difficult to pass a deficit-reduction program of the required magnitude (pp. 33â€“34).
That is the bottom line politically. It is not going to happen. So, what is the bottom line economically when the required reforms are not passed? They refuse to say. I can hardly blame them. They do comment on what will happen to the American Empire.
Just over two decades ago, the historian Paul Kennedy published his influential study of the rise and fall of great powers. His thesis of “imperial overstretch” was simple but important: the costs of carrying out an ambitious and expensive overseas policy can undermine the economic foundations of a state (p. 34).
To which I respond: “Every dark cloud has a silver lining.”
They end their article with this â€“ a plea for fiscal restraint on the welfare side, so that the nation can still pursue the course of empire.
It is fiscal, economic, and political failures at home that are threatening the ability of the United States to exert the global influence that it could and should. In other words, it is not reckless American activity in the world that jeopardizes American solvency but American profligacy at home that threatens American power and security. The American people and their elected representatives postpone solving the country’s debt addiction at their great peril.
These two Establishment spokesmen see what is coming. The American empire is about to sink in a sea of red ink. The debt-driven economic cataclysm is going to hit. The empire will be crowded out, along with economic growth.
The welfare-warfare state is going to become the welfare state. Then it will go bust. Long before it goes bust, the voters will decide not to fund the military-industrial complex’s lucrative game plan. When push comes to shove, the voters will shove the American empire away from the trough. This will end the dreams and schemes of the faceless experts who have quietly directed the ship of state ever since 1921. Their gravy train will come to an end.
This could not happen to a more deserving bunch of people.
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