Ballooning U.S. Budget Deficit a Serious Obstacle to Recovery

“The United States faces daunting economic and budgetary challenges.”
– Congressional Budget Director Douglas Elmendorf

In mythology, Troy was destroyed because its inhabitants failed to heed the warnings of Cassandra against bringing a wooden horse left by Greek invaders into their city.

It would be equally perilous for America to discount the ominous forecasts of our deficit hawks.

In January, both Moody’s and Standard and Poor’s warned that the United States might lose its triple-A credit rating if it does not stop its mushrooming national debt. The Congressional Budget Office’s budget projections show the U.S. is on a fiscally unsustainable path. The deficit is forecast to climb to $20.9 trillion by 2017.

Initially, the rating downgrades would push up borrowing costs. Over time, the government would be unable to fund its operations if lenders distrusted its political will to reign in deficits.

The latest warnings followed the $858 billion compromise by the Obama administration and Republican Congressional leaders to extend the Bush-era tax cuts and unemployment benefits for two years. The settlement emanated from a political consensus that bolstering spending will buttress our economic recovery. The Congressional Budget Office projects that the unemployment rate would fall only from 9.4 percent now to 8.2 percent by the end of 2012.

Moody’s cited the country’s failure to adopt the proposals of the bipartisan National Commission on Fiscal Responsibility and Reform. Its proposals, while not politically expedient, would have cumulatively cut $4 trillion in deficits over the coming decade.

“The U.S. could depart from the collision course with a downgrade if it took serious steps to reduce its deficit,” Kevin Hassett, director of economic-policy studies at the conservative think tank American Enterprise Institute, wrote On Jan. 30 in Bloomberg BusinessWeek…

“But President Barack Obama’s State of the Union address offered pitifully small spending cuts while floating Obama’s fiscal commission out to sea on an iceberg,” Hassett continued. “I may be old-fashioned, but all of this should mean that rating of U.S. long-term debt should be downgraded — today.”

Hassett argued that the United States probably will lose its AAA rating in six years, when our deficit reaches 135 percent of Gross Domestic Product. Hassett cited as precedent Standard & Poor’s downgrade of Japan to AA in 2001 after its deficit reached 135 percent of its GDP.

The U.S. will reach that level if we continue to run annual deficits comparable to the 2011 level of $1.5 trillion, which represents close to 10 percent of our GDP. Stated differently, the government spends 24 percent of GDP, and revenues run only 14 percent. Correcting this mismatch of revenues and expenses will require painful fiscal adjustments.

David Walker, former U.S. comptroller general and head of the General Accounting Office from 1998 to 2008, has warned that the U.S. could lose the confidence of its foreign investors within two years. According to the Treasury Department, as of November 2010, foreign central banks held $4.3 trillion of U.S. Treasury securities. Walker said the U.S. must take concrete steps to reassure foreign creditors that their dollar holdings will not devalue much further.

The Concord Coalition, a bi-partisan think tank, estimates that federal interest costs will increase from the fiscal year 2010 level of $413 billion to more than $1 trillion in the next decade. Interest costs will become our largest budget item, crowding out expenditures for defense, entitlements and needed infrastructure initiatives.

Unlike the citizens of Troy, we should heed those Cassandras who prophesy that we cannot fix our economy and add jobs on a foundation covered with red ink. We need to add revenues from a broad spectrum of the population. And, on the expense side, we must curb entitlements and the defense budget, which represent some 88 percent of expenditures.