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Published on Friday, October 22, 2004 by CommonDreams.org
The Bush Budget Deficit Death Spiral
by Robert Freeman

Lenders talk about a "debtor's death spiral." It occurs when borrowers
get so far in over their heads they begin borrowing money just to
cover the interest payments on past borrowings. The borrowers have to
do this to keep the lending flowing but they can no longer plausibly
pay down the principal. As new debt compounds on old, bankruptcy
becomes imminent. Further lending is foolhardy. Foreclosure is only a
matter of time.

The U.S. is starting to look like it is entering just such a death
spiral. It is foretold not simply by the large and growing deficits,
nor by the fact that their carrying costs will rise quickly as
interest rates rise. Rather, it is the fact that these trends are
becoming irreversible, a structural part of the U.S. economy.

When the ultimate collapse will occur, whether it comes with a bang or
a whimper, how it will be triggered, and how severe it will be are as
yet unknown. But as Herbert Stein, Chairman of the Council of Economic
Advisers under Richard Nixon was fond of saying, "Things that can't go
on forever, don't."

The first signs of impending trouble are the exploding budget deficits
themselves. They began, of course, under the parlous economic
stewardship of Ronald Reagan. Reagan cut the marginal tax rate on the
wealthiest of Americans from 70% to 38%. He promised it would spur an
orgy of investment and rocket the economy to new levels of production
and prosperity. Instead, his "supply side economics" did the exact
opposite. It produced the deepest recession since the Great
Depression.

Output fell 2.2% in 1982 while budget deficits soared. When Reagan
took office in 1981, the national debt stood at $995 billion. Twelve
years later, by the end of George H.W. Bush's presidency, it had
exploded to $4 trillion. Reagan was a "B" grade movie actor and a
doddering, probably clinically senile president, but he was a sheer
genius at rewarding his friends by saddling other people with debts.

Bill Clinton reversed Reagan's course, raising taxes on the wealthy,
and lowering them for the working and middle classes. This produced
the longest sustained economic expansion in American history.
Importantly, it also produced budgetary surpluses allowing the
government to begin paying down the crippling debt begun under Reagan.
In 2000, Clinton's last year, the surplus amounted to $236 billion.
The forecast ten year surplus stood at $5.6 trillion. It was the last
black ink America would see for decades, perhaps forever.

George W. Bush immediately reversed Clinton's policy in order to
revive Reagan's, once again showering an embarrassment of riches on
the already most embarrassingly rich, his "base" as he calls them. He
ladled out some $630 billion in tax cuts to the top 1% of income
earners. In true Republican fashion, they returned the favor by
investing over $200 million to ensure Bush's re-election. Do the math.
A $630 billion return on a $200 million investment: $3,160 for $1.
I'll give you $3,160. All I ask is that you give me $1 back so I can
keep the goodness flowing. Do we have a deal? Republicans know return
on investment.

But the cost to the public has been a return to the exploding deficits
of the Reagan years. Bush blew through Clinton's surplus in his first
year. The 2004 deficit reached $415 billion, a record. Still, its real
size is masked by the fact that Bush has shifted $150 billion from the
Social Security trust fund in order to make the shortfall look
smaller. It's like pretending you're richer when you move money from
one pocket to another. Both sums have to be repaid, so the real amount
borrowed is the $415 billion "nominal" deficit plus the $150 billion
from Social Security or $565 billion.

This shell game with federal trust funds taints all official forecasts
about Bush's deficits going forward. For example, the Congressional
Budget Office estimates Bush's cumulative ten year deficit at $2.3
trillion, to be sure, a breathtaking shortfall from the $5.6 trillion
surplus he inherited from Clinton. But as with the yearly number, this
one ignores the trust fund sleight of hand, an omission of some $2.4
trillion. When this is added back in, Bush's ten year deficit leaps to
$4.7 trillion, $10.3 trillion short of Clinton's number.

But even that number is understated because the CBO forecasts are
based on current law. Bush's tax cuts have not yet been made
permanent. If Bush is re-elected and the cuts are made permanent, that
would add another $3.2 trillion to the shortfall. It was not too long
ago that a $3.2 trillion increment to anything would have made sober
people's noses bleed but such figures are mere accounting details to
the Big Thinkers in the White House, especially since it will not be
their constituents who are paying it back.

Add it all together—the "nominal" deficit, the stealth siphoning from
Social Security, and the permanent effects of Bush's tax cuts—and the
10 year deficit explodes to a mind-boggling $7.9 trillion. Within ten
years, the government will owe more than $15 trillion. And this, at
precisely the time the government needs fiscal solvency to begin
paying the Baby Boomers their Social Security.

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 during the 1980's but almost 50% faster,
2.0%, during the 1990's.

This is the perverse, inescapable cycle—the death spiral—that comes
part and parcel with too much debt. Its relentlessly rising carrying
costs steadily erode the possibility of getting out from underneath
it. Higher debt loads lead to higher interest rates, which lead to
lower investment which leads to slower growth and, ultimately,
diminished prosperity. And it develops a runaway, recycling dynamic
all its own.

Finally, it is not only the high absolute levels of debt, nor their
rapid expansion, nor even the imminence of much higher interest rates
that consign the U.S. to the certain oblivion of a deficit death
spiral. It is that this toxic combination of circumstances has become
structural, irreversible, locked into the very nature of government
economic policy. It is like a driver hurtling down a cul de sac and
gluing his foot to the accelerator.

The very purpose of the Reagan supply side tax cuts was to funnel more
of the nation's wealth to those already wealthy. This is what David
Stockman, Reagan's Budget Director, meant when he called them a
"Trojan Horse." And they did their job wonderfully.

In 1980, the top 20% of income earners captured 43.7% of all national
income. By 1992, at the end of the first Bush administration, their
share had risen to 46.9%. Today it is over 49%. Meanwhile, the lowest
four fifths of all income earners have seen their share of national
income decline. The lowest quintile's share has shrunk from 4.2% to
3.5%. The second lowest quintile has fallen from 10.2% to 8.8%. The
middle quintile has seen its share fall from 16.8% to 14.8%. And the
second highest quintile has suffered a decline from 25.0 to 23.3%. It
is empirically the case that the rich are getting richer while
everyone else is getting poorer.

The problem this holds for national economic management is that the
rich consume a much lower percentage of their income than do those who
are not rich. How many cars can you drive at one time, anyway? The
rich are also the most likely to spend what money they do on foreign
luxury goods, take foreign vacations, make investments in foreign
countries, or just let the money sit in the bank.

The poor, working, and middle classes, on the other hand, spend
virtually everything they earn. The car needs new tires, the kids need
new shoes, the washing machine needs fixing, they're two months behind
on the rent and three months behind on the credit cards. In all of
these ways, income shifted through the tax code to middle and lower
quintile earners is quickly spent while income shifted to the wealthy
is not. This is not class warfare. It is Economics 101.

It is personal consumption—spending—that generates 67% of GDP. If more
of the nation's income goes to those who do not consume its output,
while those who do consume it have less and less income, a structural
shortfall emerges where there is simply not enough purchasing power to
sustain GDP. GDP will ratchet steadily downward in mirror image to the
rate at which national income is transferred upward.

The only recourse is for the government to step in to pump up demand.
This is the role the deficits play in sustaining GDP. This is why
deficits exploded under Reagan, Bush I, and Bush II, all of whom cut
taxes on the rich, but declined under Clinton who raised them. Rising
public deficits are necessary—in fact, indispensable—to sustaining GDP
because so much of the nation's wealth has been transferred from those
who, as a matter of necessity, spend it to those who, as a matter of
taste, do not.

Supply side economics (and that includes Bush's ill-disguised variant)
rests on the repeatedly disproved faith that investment and prosperity
are caused by giving ever more of the nation's wealth to the already
wealthy. As long as this lunacy continues to drive tax policy, the
government will keep expanding federal deficits. Eventually, possibly
soon, this will cause a collapse of the dollar that can only be
reversed by raising interest rates. But that will explode the carrying
costs on the by-then mammoth debts, vitiating private sector
investment. And that will kill all future prospects of meaningful
growth.

This is the essence of the Bush budget deficit death spiral. To be
sure, the debts are an unequalled bonanza for those few who lend the
money, for they get to do so at ever-higher rates of interest. But it
is a death sentence for all the rest of the economy.

Robert Freeman writes on economics, history and education. He can be
reached at
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