However dramatic was the dismissal last month of Gen. Stanley McChrystal as America’s field marshal in Afghanistan, it paled in significance compared with the departure of White House budget director Peter Orszag, a policy geek who goes by the nick-name “propeller head.” Orszag may be an obscure personality outside the Washington Beltway, particularly when compared to the swaggering McChrystal, but his exit from the White House signals important consequences for a global economy divided between stubborn Keynesians on one side and tight-fisted monetarists on the other.
According to press reports, Orszag resigned in frustration with his colleagues’ unwillingness to address America’s enormous fiscal deficit—estimated at more than 11 percent of its gross domestic product (GDP)—with sufficient ardor. In particular, he appealed for tax increases as well as spending cuts in order to right the nation’s heavily indebted public accounts, a proposition vetoed by President Barack Obama’s political aides with mid-term elections only four months away. Nor did Orszag, a Princeton-educated economist and protégé of Robert Rubin, the powerful Clinton-era treasury secretary, have reason to believe that a bipartisan commission tasked by Obama to produce a deficit-reduction plan would yield anything of substance; Republican Party leaders have made clear they will block any scheme that includes tax increases, period.
The tremors from Orszag’s losing battle may be felt well beyond the US, where world leaders have vowed to reduce their own record-high deficits with aggressive belt-tightening. At the recent G-20 summit meeting in Toronto, member states agreed to a compromise deal that would cut fiscal deficits in half by 2013, five years after the 2008 global financial crisis forced upon them the need for huge stimulus packages and bank bailouts. Since 2007, according to the International Monetary Fund, the average annual budget shortfall among the world’s developed economies has increased by more than eight times, to 8.4 percent this year, while overall public debt is expected to grow from 73 percent to 110 percent by 2015. The Keynesian revival that appears to have stabilized the global economy has provoked a backlash against its legacy: chronic deficits, the threat of inflation and looming fears of sovereign defaults. David Cameron, Britain’s new Conservative prime minister, for example, hopes to reduce his country’s deficit from 8 percent of GDP to 0.6 percent by 2015 with some of the most draconian fiscal and monetary policies in his country’s history.
Not all deficit-ridden states are so ambitious. Spain, for example, with a budget gap equal to 11 percent of national income, has tried to calm investors with cuts in civil-service wages. Nor is there agreement that the global economy is sound enough to endure such fiscal pain. Theoretically, deficit reduction, particularly if managed through spending cuts rather than tax hikes, inspires confidence in an economy’s long-term future, which encourages consumers and business owners to spend and invest more. The result is low interest rates, rising employment and an expanding economy.
The problem is that there is little evidence that fiscal retrenchment by itself will persuade investors and consumers to loosen their purse strings in what is still an anemic economy worldwide. Despite harsh austerity drives mounted by Greece and Ireland, for example, investors continue to demand high risk premiums for their sovereign debt. On the other hand, many economists fear that aggressive deficit-reduction measures like those advocated by countries like Germany may derail a fragile global recovery by starving markets of badly needed liquidity.
In Toronto, President Obama appears to have succeeded in staving off a one-size-fits-all austerity drive. It was a brazen appeal given his government’s own lamentable fiscal condition. He must now prove he is willing to correct America’s yawning fiscal deficit by taking the painful steps prescribed by the outgoing Orszag once the US economy stabilizes. That means cutting politically sacred entitlements and defense outlays, which, along with debt interest, account for 80 percent of total government spending.
When it comes to fiscal discipline, Washington gets a free pass; though America’s budget shortfall is greater than the eurozone’s, the dollar’s role as the world’s reserve currency insulates it from the prospect of default. With several European countries in danger of going the way of Greece, investors have flocked to US securities as a safe haven. So long as the European economy is perceived as weak, Washington will have little problem financing its record debt burden.
Thanks to foreign investors, then, the reckoning economists like Orszag have been warning about for years has been forestalled. Even Admiral Mike Mullen, the chairman of the US military’s Joint Chiefs of Staff, was largely ignored when he said publicly that the nation’s biggest national security threat was the magnitude of its national debt. America may be too big to fail, particularly given Europe’s sorry state. It may also be too soon to phase out economic stimulants for deficit reduction. Europe will eventually recover, however, and as China liberalizes its foreign exchange policies and as its economy continues to expand, the dollar’s primacy will erode. Unless Washington gets serious about deficit reduction soon, it may find itself in the same corner as countries like Greece and Ireland with nothing more than the dated idea of American exceptionalism to console it.
Stephen Glain - A former correspondent for Newsweek and covered Asia and the Middle East for the Wall Street Journal for a decade. Now based in Washington as a freelance journalist and author he is currently working on his forthcoming book about the militarization of US foreign policy.
