September 21, 2008

Next President Weakened by Financial Crisis

After the American Century

The world stock markets have been in turmoil, falling drastically and bouncing back on the news that the US Federal Government will take over huge amounts of bad debt built up by irresponsible banks. Many of them, we now know, were lending out immensely more money than they had themselves, and often lending it to people who could not afford to meet the mortgage payments. Woody Guthrie once said that some men rob you with a six-gun, others with a fountain pen. The investment banks have robbed millions of Americans, not once but twice. First, by getting them into mortgages they could not afford, and second by dumping their mistakes on the taxpayer's doorstep. Elsewhere around the world, people and institutions who bought some of this debt were "only" robbed once.

Just how much this will cost taxpayers is unclear, but early estimates suggest $1 trillion. The US does not have a surplus in its coffers, nor does it currently have a tax system that can cover this sudden additional debt. Both McCain and Obama have been talking about reducing taxes on the middle class, but after this week that may not be realistic.

Foreign investment in US government debt has been keeping the country functioning. In July of 2008 Japan and China each owned more than $500 billion in US Treasury bonds, bills, or notes. Investors from oil exporting nations have bought $174 billion. (Click here for a full list.) Why should Chinese, Japanese, and Saudi investors still buy American debt? Why not buy European government debt which has a higher interest rate? Indeed, will there be enough buyers for $1 trillion in new US treasury bills and bonds? Keep in mind that because the dollar has weakened considerably during the Bush years, such investments may not be profitable.

I hope that I am wrong, but in twenty years historians may see that the autumn of 2008 was the moment when the US lost its leadership of the world economy, and argue that it was the time when the hegemony of the American century ended. Of course, it seems that the US government has just stepped in and saved the world's economy, after its reckless bankers almost ruined it. But the nation cannot emerge stronger than its rivals from this crisis. China, Japan, India, Brazil, and the EU likely will gain on the US. Their economies have not suddenly been burdened with $1 trillion extra debt on top of an equally large debt created by the Iraq War. (For more on this, see Niall Ferguson's thoughtful op ed piece in the Washington Post.)

Even before this crisis the US budget was severely out of balance. The sudden increase in debt means that the future president will have less scope in foreign policy. It will be - even more decisively than before - a debtor nation, one which cannot afford to offend its creditors. And should the next president want to start a new war or underwrite a new peace, how is he going to pay for it?

The added $1 trillion debt will also make it harder for the next president to fund social programs, such as extending medical coverage to all Americans. All of a sudden, there is a whole lot less money to work with. Borrow $1 trillion at, say, 4%, and just servicing that debt will cost $40 billion a year. That money will not be available for schools, research, creating a new energy economy, or roads and bridges.

The next president will struggle to move forward dragging a $1 trillion ball and chain. The investment banks have not only robbed the public twice; they have weakened the next president and diminished the US standing in the world.