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The answer to this provocative question is unequivocally yes. Niall Ferguson, Harvard historian, lays out a scenario where this could likely occur. He begins by probing the borrowing binge of the US. Unless entitlements “are cut or taxes are raised, there will never be another balanced budget.” The challenge, of course, is the unfunded liabilities of the US entitlement programs. If one calculates the net present value of the unfunded liabilities of the Social Security and Medicare systems, one recent estimate puts them at about $104 trillion, 10 times the stated federal debt. Such a number is simply unimaginable! Who will buy the Treasury securities to fund this liability? There are only two real answers: The Federal Reserve, which bought the bulk of Treasuries issued in the second quarter of this year, and foreigners, who bought about $380 billion. So, let’s focus for a moment on the foreign element. Currently, the People’s Republic of China holds about 13% of US government bonds and notes in public hands. At the peak of this process of reserve accumulation, back in 2007, it was absorbing as much as 75% of monthly Treasury insurance. Will they continue to buy up our debt?
Ferguson notes rather powerfully that history supports the proposition that major financial crises are followed by major fiscal crises. History demonstrates that in the wake of debt explosions, countries have done two things: Default on their debt or allow inflation to make the debt less valuable. He writes that “The history of all the great European empires is replete with such episodes. Indeed, serial default and high inflation have tended to be the surest symptoms of imperial decline.” History demonstrates that as interest payments eat into the budget, something has to give—and that something is nearly always defense expenditures. “According to the CBO, a significant decline in the relative share of national security in the federal budget is already baked into the cake. On the Pentagon’s present plan, defense spending is set to fall from above 4% now to 3.2% of GDP in 2015 and to 2.6% of GDP by 2028.” Ferguson concludes that “This is how empires decline. It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy and Air Force. . . . If the United States doesn’t come up soon with a credible plan to restore the federal budget to balance over the next five to 10 years, the danger is very real that a debt crisis could lead to a major weakening of American power.” The precedents from history are there—Hapsburg Spain defaulted on all or part of its debt 14 times between 1597 and 1696. Prerevolutionary France was spending 62% of real revenue on debt service by 1788. The Ottoman Empire went the same way. Finally, Great Britain by the interwar years was finding that interest payments were consuming 44% of the British budget, making it difficult to rearm in the face of Nazi Germany’s threat. Ferguson concludes that “without radical fiscal reform, it could apply to America next.”
The arrogance of the current administration and the current Congress is that the United States alone will be history’s exception. I am rather confident that the US will not be that exception.
See Ferguson’s essay in Newsweek (7 December 2009), pp. 40-44. |
