Comeback America Page 15
As our deficits grow in the United States, our debt to the rest of the world—which we imprudently rely on to finance our domestic shortfall—also grows. Remember, the unified budget deficit was about 1.2 percent of GDP in fiscal 2007, and 3.2 percent in fiscal 2008. As noted above, it was about 9.9 percent in fiscal 2009. If we could bring it down to about 2 percent and keep it there, that would limit our debt to the rest of the world and our current account deficit could be stabilized at 4.5 percent for the first quarter of this century—which is still too high, but not potentially catastrophic.
If we don’t wake up, the next crisis could be much worse. What if we went into it with even greater budget and current account deficits? We would likely use the same strategies we used this time—loans and guarantees to ailing financial firms, interest rate cuts, and massive spending to stimulate a recovery. These measures worked this time because the world still trusts in the strength of the dollar and the safety of U.S. bonds. But what if trust in the United States erodes, either before or during the next crisis? In that dismal event, our economy would face skyrocketing interest rates at best, and at worst a flight from the dollar to the euro or the yen.
If that happens, farewell to America as the world’s economic powerhouse. It’s not inevitable, but it’s not inconceivable either. The dollar is weaker now than it was before the crisis. Washington’s stimulus program—which essentially involves spending money we don’t have—risks lowering the dollar’s value and stoking inflation. The Federal Reserve, which manages our money supply, has thrown all of its powers into reviving the markets by lowering interest rates to almost nothing; specifically, it reduced the Fed discount rate to .25 percent, a dramatic reduction from past levels. It also extended easy credit to bail out our financial industry—again at the risk of weakening the dollar.
It’s worth understanding what the Fed is up to. In normal times, it has a conservative balance sheet of assets (mostly U.S. Treasury bonds) and liabilities (mostly the U.S. paper currency in circulation). During the market crisis, however, the Fed’s balance sheet has more than doubled, from $870 billion to more than $2 trillion. Why has it grown? In addition to buying U.S. government bonds, the Fed has extended various kinds of credits to the American finance industry as a way of reviving our financial markets. The Fed really was the lender of last resort to these ailing firms, and it insists the loans are safe. But, well, would you have loaned money to the U.S. finance industry at that point? And some of these investments make even the Fed governors blanch. Our chief monetary authority has billions invested to keep the AIG insurance company on life support and to back J. P. Morgan Chase’s purchase of the failed Bear Stearns investment company. How does the Fed finance all of this credit? It prints more money. Any way you look at it, the Fed’s bloated balance sheet is not as conservative as it used to be.
We shouldn’t worry too much right now. Our financial system appears to have weathered the crisis of 2007–08. But America’s standing as the model for global capitalism has been damaged. Don’t underestimate the extent to which such psychological factors will weaken our leadership in the next global financial crisis. Right now we have a mortgage-related subprime crisis. Let me emphasize that we need to avoid a supersubprime crisis—one that could result from a loss of international confidence in the ability of the United States to put its own financial house in order. That kind of crisis would lead not to another recession, but to an outright global depression.
Is this a real possibility? You better believe it is, given how weak the global financial system is right now. The big agencies that judge the creditworthiness of corporations have been taking a close look lately at the financial foundations of sovereign nations. The United States has long had a Triple-A bond rating, classifying it as the safest possible investment (a status that helps countries, like companies, sell their bonds for lower interest rates). When in early 2009 I wrote an op-ed for the Financial Times expressing concern that the Triple-A rating of the United States may be at risk, domestically many people tended to discount such a possibility, but not internationally. After all, creditworthiness should not be just about the risk of the default. It should also be about the value of the currency used to repay the loan. In the op-ed I said that the outcome depends on how Washington resolves the health care reform debate and whether it will take other concrete actions to put the nation’s financial house in order.
But in May 2009, within ten days of my op-ed being published, we received an indirect warning. That’s when Standard & Poor’s, one of the premier bond-rating agencies, changed its outlook for the United Kingdom’s Triple-A rating from “stable” to “negative.”
This action meant that, while the rating had not been downgraded immediately, the likelihood that it would be had increased significantly. That action was widely seen as a shot across Britain’s bow and a possible precursor to a downgrade of Britain’s debt.
What many people overlooked was how Britain’s fiscal record compared with ours. The answer? A mixed picture, but certainly there are real areas of concern. Our budget deficit, total federal debt, and foreign debt as a percentage of the economy were as bad as or worse than Britain’s. They had some fiscal health problems at home; for example, Britain’s tax rates were already high, giving it less room to raise more tax revenue. But some of its fiscal policies were better than ours. Britain does not write a blank check for its health care costs and has already begun to reform its equivalent of our Social Security system.
That’s not to say that the United Kingdom’s or the United States’ credit ratings will definitely be downgraded soon. However, both likely will be at some point unless definitive actions are taken. We do have a history of getting our act together before we hit a wall. Hopefully that will be the case again, because the world is becoming a much more competitive place.
The rest of the world is busy drawing lessons from the recent financial collapse. The U.S. market crash taught many countries in the developing world that they need to hoard hard-currency reserves—and the dollar is still the strongest. Those healthy reserves, they hope, will give them insurance to ride out the next financial crisis.
How do they accumulate dollars? Well, they can do what China did starting in the 1990s: keep the value of their own currencies low so that they can export low-cost goods to the United States in exchange for dollars. China accumulated $2 trillion in reserves by the time the crisis hit. Now India may have plans to amass reserves of $1 trillion, according to experts monitoring its policy. And many others will choose the same path. If this scenario plays out, once again the U.S. dollar will be overvalued compared to other world currencies, once again the United States will face an oversized current account deficit, and once again we could have an overheated economy heading for meltdown.
HOW TO AVOID THE BIG ONE
How do we keep history from repeating itself, with even more disastrous consequences? Our work starts at home. After we recover from our recession, we have to take the steps I’m outlining in this book to restore our fiscal health. Once growth returns, we need to get control of federal spending to ensure that our recent free-spending and loose money policies do not usher in a devastating round of inflation.
Simply speaking, we have to balance our domestic and international checkbooks—or at least come close by cutting our current account deficit to roughly 3 percent of GDP, half its level before our latest crisis. There are several possible ways to do that. We could force our economy to run at a consistently slow rate of growth so that we spend less money on foreign imports, a strategy that no American leader ever would adopt. Or we could entice and cajole Americans into saving more of their money so that we keep more dollars at home, a strategy that might work temporarily but probably will not become a permanent feature of American life (though I’m trying!). We could also work harder to enforce equitable trade. The global trading rules we put into effect after World War II are not strong enough for a shrinking, borderless world. We need tougher rules to prevent unfa
ir currency manipulation, to regulate multinational corporations that answer to no government, and to stop protectionism.
Free trade makes sense for America. If we try to protect our auto industry, steel industry, and the like from foreign competition, they will go downhill faster than they already have. But that doesn’t mean that our trading partners should have unfettered access to our markets while they keep us out of theirs, or while they condone exploitative labor practices and do too little to protect the environment. In the end, if we want to maintain our leadership abroad, we need free trade and fair trade to serve a healthy economy at home.
We have to choose our battles carefully. We can’t compete on wages with most of the world, and frankly we don’t want to. That would hurt our own standard of living. Instead, we have to enhance the American talents for innovation, productivity, quality, and reliability. Our researchers have guided the world into the age of information technology, and we have to stay ahead of that curve. In the global production chain, America must remain the nation that comes up with the new ideas and puts them to use for everybody’s benefit. Our wages will be higher, but the value we add to a new technology and our superior productivity will keep us ahead in the global market. Let’s lead the way in the next round of information technology and telecommunications, alternative energy sources (so-called green jobs), and biotechnology.
How do we create an economy smart enough to fill that role? Getting our health care and social spending under control and restoring fiscal sanity are necessary steps. That will help us play up our other advantages: our political stability, our rule of law, and the sheer size—and voraciousness—of the American market. But we also have to smarten up our workforce. America doesn’t rank among the top twenty nations in the world in high-school-level math and science proficiency. Our high school system does a poor job of teaching civic responsibility and personal financial literacy as well. About one in three high school students fails to graduate, according to the America’s Promise Alliance, a proeducation partnership—a record that we simply must improve if we are to employ young people coming out of our educational system in the tech-intensive jobs of our future.
Our postsecondary educational system has long had ascendancy, but it is very expensive and becoming more so. America’s universities are the best in the world—factories of ideas and experimentation. Now we have to work to keep them that way. The hallmark of their success has been their openness to the best and the brightest students from around the world. But after 9/11, we tightened our visa requirements and began turning away talented scholars applying to study and do research in the United States. It took until 2007 for the State Department to resume issuing as many standard student visas as it awarded in 2001.
We lost a lot of brilliant prospects in those six years, and they have now learned there are options other than U.S. schools for pursuing their educational goals. These options will only increase in the future with advances in Internet learning and the establishment of strategic partnerships among leading universities in the United States and around the world. At a time when other university systems are boosting their resources and trying to copy the American model, we have to make sure that we maintain our own standards of robust, open, innovative higher education.
Education is the top priority for building our future, but there are others. We need to help small businesses capitalize on their export opportunities. After all, small businesses represent the engines of growth and innovation in our economy. They also employ the most people. The federal government needs to help them in the same way that Japan and other nations have helped their domestic businesses export more.
Finally, there is the issue I’ll spend most of the rest of this book analyzing: We must use this moment to shape up and smarten up our government. It was the failure of government to see the economic warning signs and take corrective action that got us into this mess. I’ll tell you from my inside perspective how we can fashion a more strategic, future-focused, results-oriented, leaner, more efficient, more responsive, and more representative government in Washington. Take hope, fellow Americans. We can build a better future if we are prepared to start work on an agenda of transformational reforms. Let’s begin by taking a look at the basic changes we need in one of the core functions of the federal government: national defense.
Nine
GETTING CONTROL
OF THE PENTAGON
As you know by now, Social Security, Medicare, Medicaid, and other “mandatory” programs (those whose spending is on autopilot) took up over 60 percent of our federal budget in fiscal 2008. The rest of the budget spending is discretionary—that is, the president and Congress can divide it up as they see fit. About half of that money—or approximately 20 percent of the entire federal budget—goes for defense. While it’s been higher as a percentage at other times (it was 46 percent of the federal budget in 1968), it still represents a major part of our budget and one in which hard choices are not always being made.
I remember coming into office in 1998 and feeling the need to get much closer to defense issues in general, and the Pentagon’s way of doing business in particular. I took a number of steps to do so over the years. Based on that experience, I came to the conclusion that we have built the best fighting forces in the world at a very high cost and with a huge amount of waste. And the nation’s defense strategy is not as comprehensive, integrated, and future-focused as it needs to be.
The Obama administration proposed a $775 billion defense budget for fiscal 2010, including funding for Iraq, Afghanistan, and other overseas military operations. By some estimates, that’s more than the rest of the world—combined—spends for national defense. There is some dispute here, since there are lots of ways to categorize defense spending, and not all countries are as transparent about their military expenditures as we are. It is safe to say, however, that of all the nations in the world the United States spends by far the most money on defense.
No responsible person would argue that we should weaken our military effectiveness. We need a strong, smart, and adaptable military force as a vital tool in the war on terror. Building a cutting-edge, high-tech fighting machine costs billions each year in research and development alone. We also have to pay the highly trained professional servicemen and-women who defend our soil. And so my point is not that our nation can be protected on the cheap. Rather, we have to clean up the waste in the system, which is contributing significantly to our fiscal crisis.
No elected official wants to appear weak on defense or anything less than supportive of our troops. And no congressman wants to go back to his district and tell people that he has voted against a weapon that provides them with jobs. For these and other reasons, some of them psychological, it’s simply hard for Congress to say no to the Pentagon. Nonetheless, if we are going to regain our fiscal sanity, we have to start asking tougher questions about our Pentagon budget. Have we built our military machine as cost-effectively as we should have? And have we retooled our fighting forces adequately for the challenges of today and tomorrow? I think you can guess my answers to those questions.
DEMANDS OF THE TWENTY-FIRST CENTURY
In order to count itself as a well-run organization during a time of fiscal crisis, the Pentagon—like the rest of government—must focus on the future and on achieving real results while also ensuring that it is giving us the best value for our money. In military terms, we need a forward-leaning, risk-based, and objectives-focused strategy.
This involves more than looking at the history of shooting wars or Cold War standoffs. Our military planners have the much tougher job of anticipating our needs in an age of terror and nuclear proliferation, and building a military apparatus to meet those challenges given the resources we have available.
Are we well enough prepared to handle weapons of mass destruction—suitcase nukes, biological agents, chemical weapons? What’s our best defense against cyber-warfare and terrorist cells that organize without regard to nationalities or borde
rs? How do we best respond to the little wars that can turn into big wars, or to the civil strife that can create breeding grounds for terrorists in the developing world? And how can we be sure that global commerce keeps flowing and our national interests are protected even if we don’t have to fire a shot? After all, as Teddy Roosevelt said, the best policy is to “speak softly and carry a big stick.” He was right, but the size of the stick should bear some proportionality to real and likely risks.
Above all, we face the challenge of international terrorism. This is not an entirely new phenomenon. Thomas Jefferson had to contend with the Barbary pirates who terrorized commercial ships of the world powers in the early 1800s. The pirates, hiding along the shores of Tripoli and other ports in North Africa, were much better organized and better armed than today’s Somali pirates. In many ways, they were a sea-based force akin to al-Qaeda. But today’s terrorists, of course, are much more lethal and mobile. They have no permanent base or strong organization. To respond to their threat, we must find new ways of conceiving and executing our military operations—rising above our own bureaucratic restraints.