Can American go bankrupt?

Bloglines | My FeedsOh yes, it can happen here

By Robert Kuttner | January 26, 2005

''How did you go bankrupt?"
''Two Ways. Gradually, and then suddenly."
Ernest Hemingway, The Sun Also Rises
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COUNTRIES GO broke gradually, by borrowing so much money that creditors lose confidence in their ability to pay the debt back. Then, they go broke suddenly as creditors stop lending.

This has happened to more than a dozen Third World nations, who had the additional misfortune of having to borrow in dollars. As their own currency lost the confidence of world markets, they lost value against the dollar. This only increased their real debt burden. The optimists say, ''It can't happen here."

First, we're the people who print dollars. So if the dollar is losing value, it just means the money that we owe the rest of the world is getting cheaper. Lucky us.

Second, we enjoy a codependency with our creditors. For instance, China, which keeps lending us money to finance our deficits, may be accumulating dollar credits that are losing their real worth. But China needs us to keep absorbing their products, so China will go right on lending.

And third, the United States remains the anchor of the world economy. So even though other nations may not like America's immense trade and budget deficits, nobody is going to risk pushing the world into depression by crashing the dollar.

That, as I say, is the optimistic view. Well, dream on.

Yesterday, the bipartisan Congressional Budget Office, possibly the last intellectually honest government agency in George Bush's Washington, reported that our fiscal situation is even worse than expected.

According to the CBO's latest ''Budget and Economic Outlook," the projected deficit for 2005 will be about $400 billion. The CBO declares, politely but unmistakably, that it doesn't buy the Bush administration's budgetary gimmickry of trying to keep anticipated military outlays out of the official budget.

''The absence of further appropriations for activities in Iraq and Afghanistan," CBO states, ''masks a further deterioration in budget projections over the [next] ten years."

Specifically, the deficit for the next decade is $504 billion worse than anticipated in CBO's previous estimate last September.

The agency goes on to warn that other challenges not currently itemized in official administration projections, such as Medicare, Medicaid, and Social Security, will only increase future deficits. And, of course, if the Bush administration succeeds either in making permanent his major tax reductions (most of which sunset after 10 years), or in adding $2 trillion of borrowing to privatize Social Security, the fiscal situation would go from merely disastrous to catastrophic.

But back to our story, ''It Can't Happen Here." America's deteriorating fiscal situation, unfortunately, is not lost either on world money markets or on the Federal Reserve. Although no world leader would willfully plunge the world into depression, that's not how markets work. Markets are purely self-interested.

Lately, markets, with good reason, have been betting against the dollar. As the US trade deficit approaches a staggering 7 percent, it's not clear how much longer foreign investors will keep investing in dollars and dollar-securities, such as corporate stocks and government bonds.

As for the Chinese, Clyde Prestowitz of the Economic Strategy Institute, formerly a senior trade negotiator in the Reagan administration, offers the following scenario: In a future crisis involving the tense China-Taiwan relationship, the Chinese ambassador suggests to Secretary of State Condoleezza Rice that maybe the United States would like to move its warships 500 miles away from Taiwan. Rice demurs. The next day, the Bank of China sells a few --just a very few to get our attention -- US Treasury securities. Money markets reel.

Would the Chinese play such a risky game? They have their own interests, geopolitical as well as economic. They are certainly not an American pawn, less so with every passing year. Miscalculations have happened in world economic relations before, and with calamitous results.

The Federal Reserve, meanwhile, is increasingly worried about inflation, largely of the imported variety due to the weak dollar. The Fed is steadily raising interest rates. With every quarter-point hike, consumers pay more for mortgage and credit card loans, investors in stocks become more wary, and the air goes out of the economy. Alan Greenspan kept rates very low long enough to get George W. Bush reelected. Now he is reverting to type.

The Bush administration is putting itself, and America's economic future, in grave jeopardy. The only good news is that all this bad news makes Social Security privatization, or permanent tax cuts for the wealthy, less than an even bet.