Comeback America Page 14

  Others have more dramatic proposals for transforming our tax system. Former House majority leader Dick Armey (R-TX) has long advocated a “flat tax.” Under this approach, the tax base would be broadened and all taxpayers would pay a single tax rate on all taxable income above a stated level. Wages would continue to be subject to Social Security and Medicare payroll taxes.

  An even more dramatic tax reform approach has been advocated by Representative John Linder (R-GA) and others. Under their “fair tax” proposal, all individual and corporate income and payroll taxes would be repealed and replaced with a national consumption-based tax of about 30 percent on all purchases of goods and services. All individuals would receive a tax credit for purchases up to a stated level (for example, $10,400 for one person and $21,200 for a family of four in the continental United States). This approach would attempt to preserve the benefits of a consumption tax while avoiding its impact on our less-well-off fellow citizens. A side benefit of this approach, some assert, would be the elimination of the IRS—although some federal entity would need to manage the new system of credits. Irrespective of the intellectual merits of this system, the political feasibility is highly questionable.

  The fairness of any new federal system would have to be judged by how equitably the burdens are shared by Americans rich and poor. We must also be concerned with the adequacy of our tax system. In the final analysis, it must generate enough revenues to pay our bills and deliver on the promises that the federal government intends to keep.

  By now you recognize my mantra. The expansion of government over time, excessive spending, and the continuing cry for tax relief have been driving us toward bankruptcy. What we need is tax reform: a simpler, fairer, more transparent, and user-friendly system that brings sufficient revenues into our Treasury and uses them more productively—not to finance more unaffordable and unsustainable wants, but to meet essential needs for America and Americans. I have outlined some of these reforms in this chapter. These reforms not only will assist in our pursuit of happiness, they will boost America’s competitiveness in the global economy.

  It’s time to look more closely at our place in the global economy. Our international trade and financial policies have something in common with the domestic issues I’ve been talking about up to this point: They are in disarray. We have become increasingly enamored with imports and reliant on foreign lenders. These trends, if not reversed, risk weakening our foreign policy, threatening our national security, and even harming our domestic tranquility over time. I’ll show you how in the next chapter and explain how we can improve our international standing.

  Eight

  ADDRESSING AMERICA’S

  INTERNATIONAL DEFICITS

  Have you ever sensed while traveling abroad that Americans are both loved and hated just a little more than other foreigners? It might be understandable why people may have problems with the American attitude—we can be pretty confident, direct, and headstrong. But why are we favored at the same time? It ain’t our personalities. It’s what we carry in our wallets—the good old American greenback.

  America has been a world leader since World War II—in fact, we’ve been the world leader. We are the greatest military power, we have the biggest market, and we hold exaggerated influence in international councils. (There I go, talking like the kind of American the world loves to hate!) For sixty-five years it has been easy to identify the keystone of our global economic might: the U.S. dollar. The strength of our democracy and the dominance of our economy have made the dollar a powerful tool of global commerce. In fact, the rest of the world has long used the dollar as the international currency of choice. American money has become the world’s money. But recent economic troubles have caused a lot of foreign investors to take another look at the dollar. That’s why I worry that our fiscal crisis is damaging not only our lifestyle at home, but our standing in the world.

  We have become as addicted to deficits and debt in our international policy as we have at home. We now import much more than we export, a practice that leaves us with a sizable trade deficit—that is, the difference between what we buy and sell internationally. In recent years we have spent hundreds of billions, and in 2008 over 700 billion, more dollars in the global economy than we have taken in. During my lifetime, we have also gone from being the world’s largest creditor nation to the world’s largest debtor nation internationally. These trends already have left us more vulnerable to international rivals. Unless we clean up our act, we will pass on a much more dangerous world to our heirs.

  We have largely inflicted these troubles on ourselves. You know my bottom line on that practice. It is fiscally irresponsible and morally reprehensible, and it threatens our collective future. This chapter examines how that profligacy is hurting America’s international standing and looks at how we can avoid an even bigger crisis down the road.

  I can offer you my own perspective on these issues. Though I mainly served the U.S. government, as comptroller general from 1998 to 2008, I also served on the board of the International Organization of Supreme Audit Institutions, the U.N.-affiliated professional organization for the top national audit institutions in 189 countries around the world, and as chairman of the first ever Strategic Planning Task Force for that organization. Today, I still watch international finance closely as chairman of the Independent Audit Advisory Committee of the United Nations, and I was recently named as one of fewer than four hundred global members of the Trilateral Commission. These and other positions have put me in touch with government and economic leaders around the world, and some of their private doubts about U.S. strength and steadfastness should set off alarm bells in Washington.

  FINANCING AN ISOLATED NATION

  I tell my interlocutors abroad that if you want to understand the United States, don’t look just at our policies today, look at our history and culture. We began our nationhood determined to set ourselves apart from the currents of international affairs, even if that looked to our foreign partners and rivals like a world-be-damned policy. You can still see strong reflections of that attitude today, most recently in the policies of President Bush 43, who in many cases regarded international cooperation and compromise as a weakness.

  The truth is that in our early days we saw little need for international diplomacy. The United States was a largely self-sufficient agrarian nation that exported cotton, tobacco, and other agricultural products, and imported little more than a few manufactured and luxury items. Until the federal income tax came along in 1913, we financed our national government mostly on proceeds from import duties and tariffs.

  We avoided excessive debt throughout that era. Let’s take special note of the year 1834. America actually got its financial act together that year and became almost debt-free. Dig out that old balance sheet, because we’ll never see that condition again.

  During the Civil War, trade issues played a role that is not discussed very much. England was more industrialized than the United States, but it had grown dependent on cotton, tobacco, and other agricultural exports from the southern states to supply its textile industries and to meet English consumer demand. As a result, England provided unofficial support to the Confederacy, much of which was coordinated from Bermuda, although it never officially recognized the Confederate States of America as an independent nation.

  The United States finally took notice of the outside world under President Theodore Roosevelt, who is one of my favorite presidents. Among other things, TR was an internationalist who was committed to bringing the United States out of its shell and putting it on the world stage. His deployment of “the Great White Fleet” showed off America’s military might.

  Our power and the strength of our export economy grew with industrialization. This growth continued through two world wars and the Great Depression of the twentieth century. At the end of World War II, the United States emerged as the only major country whose mainland had escaped attack. That strength and our ingenuity and productivity catapulted us into
global economic and political supremacy whether or not we wanted that status. After World War II ended, the United States alone represented more than 50 percent of the global economy. In many ways, we were the global economy, and the dollar was deemed to be as good as gold. In fact, the dollar was backed by gold at a fixed rate of $35 an ounce.

  The trade agreements after World War II made it official: The dollar was singled out as the official currency for international commerce. We have been taking that for granted ever since. We shouldn’t.

  PRELUDE TO A MELTDOWN

  Why does the era of the Almighty Dollar seem to be coming to a close? Without question, our success in reviving the global economy created other power centers—including Japan and Germany—that claimed their own place in the sun. The real troubles for the dollar began in 1971, when President Nixon took it off the gold standard; he acted in part because Vietnam War spending had led to inflation and deficits, prompting France and other countries to start demanding gold for their dollars. The so-called Nixon Shock sent oil prices, which were denominated in dollars, much higher. Interest rates also rose sharply.

  The dollar has been less stable ever since. Now that it is no longer tethered to gold, its value has gone up or down like any other market commodity. When the value of the dollar is low, and may be headed lower, investors tend to demand higher interest rates to buy our bonds. That increases our costs, raises the size of our national debt, and gives our government less money to spend at home.

  While the value of the dollar is important, the rate at which it changes value is also important. A sudden and dramatic decline in the dollar can cause serious damage to our economy.

  Since our borrowing is more and more dependent on foreign lenders, our economy is becoming steadily more vulnerable to foreign influence. While total debt reached a record 122 percent of our gross domestic product (GDP) after World War II, it was all owed to Americans. Today, over 50 percent of our public debt is held by foreign lenders. And that percentage is increasing.

  Why do we borrow so much money? Because we spend too much! You know from previous chapters that we Americans have become a nation of spenders, not savers. Here’s how that affects our position in the world. Consider all the money, goods, and services that constantly flow into and out of the United States. The difference between what we buy and what we sell is called our trade balance. If we buy more than we sell, we have a trade deficit. We have run such a deficit for many years now. Why is that bad? Stay with me.

  From a broader perspective, the trade balance combined with a few other international transactions—including dividends on investments and other transfer payments from abroad—give us what we call our current account balance. This is something like a national checking account for international transactions. Unfortunately, just like the federal government’s domestic account, that checkbook is badly out of balance. In 2006, the current account deficit exceeded 6 percent of our GDP (the market value of all the goods and services we produce in a year—a little over $14 trillion in 2008). (See figure 10.) That’s a very unhealthy level. It pushes down the value of the dollar and it can’t be sustained over time.

  When we spend money we don’t have, we must borrow money to pay our bills. During the recent boom years, there were plenty of lenders out there. For years, China and other countries financed our deficit by buying our Treasury bonds at extremely low interest rates.

  That was for their own good in the short term, because their bond purchases kept U.S. consumer interest rates low and housing prices high—so that America could continue to buy China’s and other countries’ exports. And we Americans were delighted to cooperate so we could have what we wanted no matter whether we needed it or not.

  Figure 10 U.S. current account surplus and deficit as a percentage of GDP. Our international checkbook is far from balanced.

  We wanted a lot. Historically, consumer spending has accounted for 60 to 65 percent of our national economic activity. But as the economy heated up, Americans went on a shopping spree, and consumer spending increased to 72 percent. This is also unhealthy and unsustainable.

  Credit became cheap and easy to get. Billions of dollars in that easy money poured into the housing market, where mortgages went on sale for bargain rates, and the housing-price bubble expanded until the big pop of 2007–08 brought our entire financial system to its knees. What is the lesson? You can’t spend more money than you make forever without the risk of suffering a major trauma—call it a financial heart attack.

  So here’s the dynamic that led to our crisis: Foreign investors flooded us with cheap money, stoking our consumer frenzy. They gave us “more than enough rope to hang ourselves,” as C. Fred Bergsten, director of the Peterson Institute of International Economics, puts it. But in the end, foreigners were not to blame for what happened. We did the irresponsible spending.

  THE DOLLAR’S TRAJECTORY

  In the past, the preeminence of the dollar has protected us from our own worst habits. To put it bluntly, we could routinely get away with profligate spending and imprudent fiscal practices. The markets couldn’t punish our currency too much because it was the currency.

  Now that advantage is no longer quite such a sure thing. The dollar isn’t nearly as strong as it was after World War II. The United States now represents about 23 percent of the global economy in 2008, down from over 50 percent after World War II—still the largest on the planet, but not utterly dominating. The dollar is on a similar downward trajectory.

  The dollar has a competitor now—the euro—and a few other currencies, including the British pound and the Japanese yen, are also used in international trade. As of this writing, sixteen of the twenty-seven members of the European Union had adopted the euro as their official national currency. The United Kingdom and Denmark (who are in the European Union) and Norway and Switzerland (who are not) were the only major exceptions in western Europe.

  Could the euro or another currency replace the dollar as the world’s premier reserve currency? The answer is yes. In September 2007, Alan Greenspan said that it is “absolutely conceivable that the Euro will replace the dollar as reserve currency or [that it] will be traded as an equally important reserve currency.” More recently, World Bank president Robert Zoellick, the former U.S. trade representative, noted that the euro provides a “respectable alternative” to the dollar and that the Chinese renminbi is likely to grow in importance. If that is true, we will have even more trouble managing our domestic and international deficits.

  National treasuries around the world already are relying less on the U.S. dollar than they once did. A very important one, China, has been aggressively spending down its dollar reserves on commodities in order to hedge against a decline in the dollar’s value and the potential of inflation.

  I have been involved in a number of high-level meetings on these topics, and they continue into the present. In 2007, Chinese premier Wen Jiabao asked to meet with me during one of my visits with my Chinese counterpart, Li Jinhua, head of the Chinese National Audit Office. Premier Wen asked me about the projected financial condition of the U.S. government. I didn’t say anything to him privately that I had not said in the United States publicly. Needless to say, the numbers spoke for themselves, and he got the message.

  In early 2009, Wen stated his concern publicly. Soon after he made his statement, a leading official of China’s central bank raised the question whether the world had grown too dependent on the U.S. dollar and suggested that it might explore other global currency options.

  President Obama and various high-ranking U.S. economic officials tried to reassure China and others that the dollar remains as strong as ever, and that it will survive today’s crisis with its power intact. Treasury Secretary Timothy Geithner traveled to China and assured a big audience at Beijing University that their country’s U.S. investments were safe—but it didn’t help when the assembled students greeted his comment with laughter.

  The Chinese are not the only investors concerned abo
ut the fiscal behavior of the U.S. government and America’s low savings rates. I have heard top officials from the Organization of Petroleum Exporting Countries (OPEC) express their own concerns on these issues. In my view, it is not a matter of if but when OPEC nations no longer use the dollar as the sole means to price oil. Kuwait, a strong ally of the United States and a key OPEC member, has already pegged its dinar to a basket of currencies to value its oil exports. This slightly reduces the attractiveness of the dollar and, more important, sends a signal to others.

  THE NEXT CRISIS

  China, Japan, Germany, and other countries profited greatly from America’s consumption binge in recent years. But they and every other major economy on Earth were swept into the 2009 crisis to one degree or another. Most were in recession, and others, like China, grew at much slower rates.

  The great engine of growth, the United States, had stopped buying nearly as much from overseas. That, plus a drop in oil prices, narrowed our current account deficit somewhat, at least for the short term. But that was good news only for us. The decline of our market forced exporters like China to look inward. If they wanted growth, they would have to expand their domestic markets. What if they failed? That would further weigh down the global economy. The financial disaster that began in the United States might be extended and deepened.

  The drop in international trade probably won’t help the dollar. Even under President Obama’s rosiest scenario, the U.S. current account deficit will be high, putting greater pressure on the world’s reserve currency before the economy recovers. After the government launched its expensive rescue and stimulus plans in late 2008, the CBO estimated that our fiscal 2009 deficit would reach an astounding 8.3 percent of GDP—more than three times the average 2.3 percent. (The OMB announced in October 2009 that the deficit for fiscal 2009 was $1.42 trillion, or 9.9 percent of GDP.) Even the 8.3 percent figure prompted concern among a number of international leaders. Obama’s suggestion that they follow the United States in passing a huge domestic stimulus program was poorly received in many quarters. Czech prime minister Mirek Topolánek, whose country held the EU presidency, denounced Obama’s plan as “the way to hell.”