IN nature, every action has
consequences, a phenomenon called the butterfly effect. These
consequences, moreover, are not necessarily proportional. For
example, doubling the carbon dioxide we belch into the atmosphere
may far more than double the subsequent problems for society.
Realizing this, the world properly worries about greenhouse
emissions.
The butterfly effect reaches into
the financial world as well. Here, the United States is spewing a
potentially damaging substance into our economy — greenback
emissions.
To be sure, we’ve been doing this
for a reason I resoundingly applaud. Last fall, our financial
system stood on the brink of a collapse that threatened a
depression. The crisis required our government to display wisdom,
courage and decisiveness. Fortunately, the Federal Reserve and key
economic officials in both the Bush and Obama administrations
responded more than ably to the need.
They made mistakes, of course. How
could it have been otherwise when supposedly indestructible pillars
of our economic structure were tumbling all around them? A
meltdown, though, was avoided, with a gusher of federal money
playing an essential role in the rescue.
The United States economy is now
out of the emergency room and appears to be on a slow path to
recovery. But enormous dosages of monetary medicine continue to be
administered and, before long, we will need to deal with their side
effects. For now, most of those effects are invisible and could
indeed remain latent for a long time. Still, their threat may be as
ominous as that posed by the financial crisis itself.
To understand this threat, we need
to look at where we stand historically. If we leave aside the
war-impacted years of 1942 to 1946, the largest annual deficit the
United States has incurred since 1920 was 6 percent of gross
domestic product. This fiscal year, though, the deficit will rise
to about 13 percent of G.D.P., more than twice the non-wartime
record. In dollars, that equates to a staggering $1.8 trillion.
Fiscally, we are in uncharted territory.
Because of this gigantic deficit,
our country’s “net debt” (that is, the amount held publicly) is
mushrooming. During this fiscal year, it will increase more than
one percentage point per month, climbing to about 56 percent of
G.D.P. from 41 percent. Admittedly, other countries, like Japan and
Italy, have far higher ratios and no one can know the precise level
of net debt to G.D.P. at which the United States will lose its
reputation for financial integrity. But a few more years like this
one and we will find out.
An increase in federal debt can be
financed in three ways: borrowing from foreigners, borrowing from
our own citizens or, through a roundabout process, printing money.
Let’s look at the prospects for each individually — and in
combination.
The current account deficit —
dollars that we force-feed to the rest of the world and that must
then be invested — will be $400 billion or so this year. Assume, in
a relatively benign scenario, that all of this is directed by the
recipients — China leads the list — to purchases of United States
debt. Never mind that this all-Treasuries allocation is no sure
thing: some countries may decide that purchasing American stocks,
real estate or entire companies makes more sense than soaking up
dollar-denominated bonds. Rumblings to that effect have recently
increased.
Then take the second element of
the scenario — borrowing from our own citizens. Assume that
Americans save $500 billion, far above what they’ve saved recently
but perhaps consistent with the changing national mood. Finally,
assume that these citizens opt to put all their savings into United
States Treasuries (partly through intermediaries like
banks).
Even with these heroic
assumptions, the Treasury will be obliged to find another $900
billion to finance the remainder of the $1.8 trillion of debt it is
issuing. Washington’s printing presses will need to work
overtime.
Slowing them down will require
extraordinary political will. With government expenditures now
running 185 percent of receipts, truly major changes in both taxes
and outlays will be required. A revived economy can’t come close to
bridging that sort of gap.
Legislators will correctly
perceive that either raising taxes or cutting expenditures will
threaten their re-election. To avoid this fate, they can opt for
high rates of inflation, which never require a recorded vote and
cannot be attributed to a specific action that any elected official
takes. In fact, John Maynard Keynes long ago laid out a road map
for political survival amid an economic disaster of just this sort:
“By a continuing process of inflation, governments can confiscate,
secretly and unobserved, an important part of the wealth of their
citizens.... The process engages all the hidden forces of economic
law on the side of destruction, and does it in a manner which not
one man in a million is able to diagnose.”
I want to emphasize that there is
nothing evil or destructive in an increase in debt that is
proportional to an increase in income or assets. As the resources
of individuals, corporations and countries grow, each can handle
more debt. The United States remains by far the most prosperous
country on earth, and its debt-carrying capacity will grow in the
future just as it has in the past.
But it was a wise man who said,
“All I want to know is where I’m going to die so I’ll never go
there.” We don’t want our country to evolve into the
banana-republic economy described by Keynes.
Our immediate problem is to get
our country back on its feet and flourishing — “whatever it takes”
still makes sense. Once recovery is gained, however, Congress must
end the rise in the debt-to-G.D.P. ratio and keep our growth in
obligations in line with our growth in resources.
Unchecked carbon emissions will
likely cause icebergs to melt. Unchecked greenback emissions will
certainly cause the purchasing power of currency to melt. The
dollar’s destiny lies with Congress.
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