The Other Red PerilDeficits, Debt and US Power

The Age of Deficits…

... And The Age of Debt

The New Red Peril: C21 Debt Projections

Roots of the New Red Peril: Entitlement Spending

An even worse scenario – entitlements and interest payments

... And inadequate federal tax revenues

But tax increases are not the sole answer!

The Political Impasse ...

• Broad consensus that deficit and debt control are essential but no agreement about means

• Republicans insist that spending retrenchment is the only solution

• Democrats want mix of spending cuts and revenue enhancement

• Efforts to depoliticize the deficit/debt solution – Obama Fiscal Commission, congressional super-committee – founder on rocks of partisan polarization and ideological inflexibility

... But deficit/debt is embedded in structural problems of post-1980 economy

• The Volcker Fed’s success in conquering inflation through the monetarist ‘shock’ of 1979-82 stabilized the value of money

• But real interest rates remained high because of the need for foreign capital to make up the deleterious effect of the Reagan-era fiscal deficits on national savings

• The effect was a burgeoning trade deficit as a strong dollar sucked in imports and the hollowing out of US manufacturing

The US Trade Deficit

The ‘financialisation’ of the US economy

• High interest rates meant that profits increasingly derived from provision/transfer of capital. Production share of GDP fell from 30 percent in 1970 to 16 percent in 2000, FIRE rose from 15 percent to 24 percent (this sector increasingly sought high return in relatively short time)

• Financialisation exacerbated income inequality: in 1976, richest 1 percent owned 9 percent of nation’s pre-tax wealth; in 2007, its share was 24 percent (richest 0.1 percent got 12 percent)

• Low interest rates (1996-1999, 2002-2005) produced speculative frenzies in high-risk financial ventures – dot.com boom, sub-prime mortgages

What is to be done?

• US needs to save, produce and export more; borrow, consume and import less

• Only about 4 percent of US firms (15 percent of manufacturing ones) do any exporting at all; and just 1 percent of firms account for 80 percent of US export value

• In 2010 exports made up 10.9 percent GDP; the US needs to get to 20 percent in a relatively short time to achieve economic rebalancing

How? The state’s constructive role

• Key to rebalancing is timely pre-emption of fiscal crisis i.e. not too soon to flatten recovery, but in time to prevent debt undermining economic foundations

• This needs political agreement on entitlement control and tax increases

• It also necessitates creating adequate fiscal margin for (i) defence and (ii) public investment (education & training, infrastructure, green initiatives) to enhance productivity

What Obama can do? One option...

... Or “Teach Reality”

• Abandon meaningless rhetoric of keeping the American economy “No 1” in the world

• Teach the reality that rebalancing is needed through a shift from financialisation to production, but that this will involve pain (borrowing/consumption restraint)

• Find a positive way of asserting the role of the state in America’s economic renewal because the market is the problem not the solution

• Use American influence to promote international economic coordination towards global rebalancing and elimination of distorting trade and capital flows

Without fiscal/economic course correction ...

• The US enters a period of steady economic decline from the 2030s onward

• As economic power is critical to both its hard and soft power, America’s preeminent global position cannot be sustained

• Increasing income inequality leads to growing lack of social cohesion at home