Competing projections for America’s future debts have emerged from the White House Office of Management and Budget (OMB) and the non-partisan Congressional Budget Office’s (CBO) assessments of US President Barack Obama’s recent budget proposals. Much observer attention has focused on the disparity between the two projections—$1.2 trillion over the decade, but what is most troubling is what they have in common: a major increase in the level of government indebtedness as a share of GDP. While looking at economic tea leaves can be a precarious business, they do provide the best basis we have of anticipating future developments and better preparing ourselves for the consequences.
The Obama administration’s budget projections through 2020 keep the federal budget deficit above 3.5 percent for the entire decade. The CBO thinks that 4.5 percent will be the real floor. Without major changes, the United States appears to be on track for a sustainable long-term debt level of somewhere around 80 percent of GDP. This level, while not desirable, is also not catastrophic, especially as squaring the circle of this deficit financing might not be as problematic as many suggest. American tax rates remain relatively low compared to European countries; indeed, they remain well below the American rates of the booming nineties. Raising taxes to the levels seen in the Clinton years would make substantial inroads into these deficits and debts regardless of whose figures are used. However, as the recently concluded debate over health care reform revealed, there are major institutional and partisan obstacles to such major changes in existing policies. Whether President Obama or any of his successors can overcome these roadblocks remains highly questionable.
American fiscal deficits are just one of the United States’ twin deficits – the other being its ongoing trade deficit. The United States’ last trade surplus was in 1975. For a generation the world has known only large, and frequently rising, American trade deficits. The economic crisis has put a dent in the trade deficit, which fell from its previous record in 2008 of $696 billion to a still substantial $381 billion in 2009. A return to normalcy will likely lead to further erosion in the US balance of payment. This, more than anything else, will pull the dollar back to earth when the current economic crisis has passed. The recent attractiveness of the US dollar has much more to do with the absence of other safe harbors for money than any underlying strength of the United States’ trade and fiscal position.
Currency prices are relative and the few alternatives to the dollar also confront challenges. The euro has been going through troubled times of late. While its trade is roughly in balance, the financial position of some EU member states is seen as precarious. It remains to be seen whether the fiscal turmoil seen in tiny Greece will be replicated in larger Spain and Italy. However, the Eurozone’s limits on the size of the fiscal deficits of its members provide a powerful constraint that is lacking on the United States’ federal government. Even without any changes, the US fiscal position more closely resembles Germany’s than it does Europe’s southern states. The American trade position, on the other hand, is the inverse of Germany, the world’s number two exporter after China.
And, of course, whatever the talk of a “strong dollar,” it is the official policy of the United States that China should let the undervalued renminbi float against the dollar. Experts are in broad agreement that the consequences of removing the peg between the dollar and the renminbi would be an appreciation of the Chinese currency of between 25-40 percent. This would likely cripple China’s export-oriented economic strategy, but American policy-makers are increasingly attempting to engineer further revaluation of the renminbi.
As the world economy emerges from the Great Recession, investors once again slowly start to look at investments that earn higher rates of return than safe government bonds. Gains from a recovery in the American economy are likely to be tempered by a slackening in demand for the dollar. Europe holds some prospects as the euro continues to establish itself as a regional alternative to the dollar, but the real growth prospects in the European Union are likely to be in the eastern members, most of whom have not yet adopted the euro. In this climate, economies in the developing world, especially success stories like China, India and Brazil with their combination of perseverance and sustained growth in the face of the financial crisis, will begin to look even more attractive.
Dr. Mark Duckenfield – Professor of International Political Economy at US Air War College, Maxwell Air Force Base
The views expressed in this article are those of the author and not necessarily those of the US Air War College or the Department of Defense.
