Now that the U.S. Treasury’s credit rating has been cut by one of the three major rating agencies, and the stock markets are in turmoil, we should think about how we got into such a state and where it may lead long-term.
Conventional wisdom, partly true, is that war spending does not have much of a role because it’s small relative to GDP (compared with past cases like WWII and even Vietnam). But I think wars have bigger economic effects than generally realized.
At the start of the Iraq War, I wrote that George W. Bush’s plan to CUT taxes in wartime was historically unprecedented and would lead to terrible economic consequences (The Real Price of War). Wars are super expensive, and more than a trillion dollars have gone down the drain in Iraq and Afghanistan since that book appeared. Or maybe several trillion dollars, depending how you count. Bush’s tax cuts and war expenses were a big part of driving up the federal debt.
The New York Times had a nifty graphic recently illustrating that of our current $14 trillion debt, more than $6 trillion accumulated during the Bush years. Another $2.4 came during the Obama years, but most of that was paying for Bush’s wars and stimulus to counteract Bush’s recession. So I don’t see the latest crisis as a “Tea Party downgrade” so much as a Bush Downgrade. The Republicans say to stop whining about Bush, and the public has a short memory as usual, but it’s like someone steals everything you have and burns your house down, then tells you a few years later that that’s ancient history and it’s your own fault you’re poor.
So we have a big debt. Who holds it? China is indeed the largest foreign government creditor at $1.2 trillion, but almost three times that amount is held by other foreign governments, and even more by private individuals, companies, and banks ($3.6 trillion). The largest holder of U.S. government debt, at about $6 trillion, is the U.S. government, mostly Social Security and other trust funds.
How will the USA ever pay it back? Historically, there is a way that countries pay huge war debts. They print too much of their currency and cause its value to fall, thereby letting themselves pay off debts with funny money instead of valuable money. This is a huge simplification but explains the core of what happens. My 1988 book Long Cycles showed that over five centuries recurrent spikes of inflation followed major wars. In the past decade U.S. wars have been far from major in historical terms, and the current quasi-recession holds down inflation for now, but over the coming years I consider inflation likely.
The Chinese and other holders of Treasury debt should not be too worried about default (a failure to make payments on time). Rather, they should worry that the money they get paid back in will be worth a lot less than the money they paid in the first place. The U.S. government is in the admirable position of borrowing in a currency whose value it controls.
Admittedly I have been worrying about inflation for quite a while and it has not materialized. But those of you young enough not to remember the 1970s (the last time the United States had double-digit annual inflation) might not even know what the word means. It would be worth learning it.
What happens next? James Lindsay at the Council on Foreign Relations makes a good case that the special bipartisan Congressional committee will fail to reach agreement this Fall. It seems likely that not much progress on governance will occur until the 2012 elections sort out what direction we’re going. Meanwhile the operative math is:
Debt Deal of 2011 — $2.4 trillion.
Hearing the “socialist” Chinese leadership criticize the capitalist United States for its “bloated social welfare costs” — Priceless.