Sample text for Running on empty : how the Democratic and Republican Parties are bankrupting our future and what Americans can do about it / Peter G. Peterson.

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Excerpt from Running on Empty: How the Democratic and Republican Parties Are Banking Our Future And What Americans Can Do About It by Peter G. Peterson. Copyright © 2004 by Peter G. Peterson. Published in August, 2004 by Farrar, Straus & Giroux, LLC. All rights reserved.


Less than three short years after America absorbed the double blows of 9/11 and the collapse of the bubble economy, a new mood of triumphalism reemerged in many quarters. Saddam Hussein was dragged from his spider hole and humiliated before the world. Inflation and interest rates remained low while productivity and profits soared. The stock market roared back and investors began reading their statements again. So quick was the rise in manufacturing and consumption that freight backed up on the nation's railroads and waterways.

Yet if it seemed the dawn of another "Morning in America," many Americans still felt a chill in the air: at what price did America purchase its recovery? Yes, nearly everyone agreed that tax cuts and a big run in federal spending had helped to stimulate the economy. Everyone agreed the Fed had been right to cut interest rates. But even after three big tax cuts in a row, a boom in home refinancing, and zero percent auto loans, the economy was slow to produce jobs, personal savings rates skidded to historic lows, and the nation faced ballooning budget and trade deficits stretching as far as the eye can see.

Meanwhile, the oldest baby boomers are just a few years away from retirement. Today, Social Security still runs a sizable cash-flow surplus, which covers the roughly equal cash-flow deficit in Medicare. But official projections show that within fifteen years both programs will be paying out far more in benefits than they collect in taxes, with Medicare's red ink far surpassing that of Social Security. Indeed, if one looks at Social Security and Medicare together, including both Medicare's hospital and physician programs, they go from a modest combined cash-flow deficit of about $25 billion in 2003 to an unthinkable annual cash-flow deficit of $783 billion in 2020 (or $519 billion in today's dollars). And that annual deficit is projected to reach $4.3 trillion (that's $4,300 billion) by 2040 (or $1.6 trillion in today's dollars). No longer will Congress be able to use Social Security tax dollars to pay for Medicare's deficits or for other government operations. Unless Social Security and, in particular, Medicare benefits are brought under control, the government will face stark options: either draconian cuts in defense, education, transportation, the criminal justice and other programs, or huge tax hikes—or, of course, both.

What were the politicians preparing to do about all this? The Republicans wanted to make all of their recent tax cuts permanent, while also pushing for big increases in spending on defense, homeland security, energy subsidies, and miscellaneous pork. Meanwhile, the Democrats vowed to do away with the tax cuts for the rich, preserve tax cuts for the middle class, put new money into education, health care, highway construction, and miscellaneous pork while promising to do nothing about the big deficits in Social Security and Medicare—except perhaps to make them bigger. After a costly new expansion of Medicare to pay for prescription drugs, the Democrats complained it "didn't go far enough," thereby suggesting we make an already unsustainable program even more unsustainable.

America was back, but for how long? Were we celebrating an economic Pyrrhic victory?

Buried deep in the financial pages, telltale signs are appearing that suggest America may well be headed for a financial meltdown. In January 2004 the staff of the International Monetary Fund, who normally worry about profligate nations like Argentina, took direct aim at the United States, warning the world that we are careening toward insolvency. They point to a huge and growing imbalance between what the federal government has promised to pay in future benefits and what it can reasonably expect to collect in future taxes. Its long-term structural deficit now exceeds 500 percent of gross domestic product. Closing that gap, the IMF calculated, "would require an immediate and permanent 60 percent hike in the federal income tax, or a 50 percent cut in Social Security and Medicare benefits."

Adding to the gathering fiscal storm is America's growing dependence on foreign capital. Because Americans import far more goods and services than they export, and because the federal government borrows so much and Americans save so little, the American economy is increasingly owned by, or indebted to, foreigners. This is America's other deficit, the so-called current-account deficit, which indicates how much of our birthright we are selling off to foreigners, or promising to pay them in future interest payments. Last year the United States imported capital from foreigners at an unprecedented rate—four billion dollars every working day.

These "twin deficits"—the U.S. budget deficit and America's current-account deficit—pose a dual challenge. Today's budget deficits consume so much of the nation's meager savings that we must turn to other countries to finance our home mortgages, credit card balances, and the business investments that fuel our growth. Thus, if foreigners stopped providing us with so much easy money, interest rates would likely shoot up, the dollar would likely sink, and the economy would likely stall. This flow of easy money also reduces pressure on our government to cut its own reckless borrowing, and on ordinary Americans to reduce their consumption and increase their savings.

For a long time this arrangement has been a boon for American consumers. This borrowing from abroad allowed us to buy lots of cheap imports, even if it caused many Americans to get hooked on credit and others to lose their jobs to foreign competition. Fred Bergsten, director of the Institute for International Economics, observes, "We finally understand the true meaning of supply-side economics. Foreigners supply most of the goods and all of the money."

But the arrangement cannot last indefinitely: we have for too long consumed far more than we have produced as a nation. International economists agree that the odds of severe adjustment problems mount rapidly once an economy exceeds a current account deficit of 5 percent of GDP. In 2003 our current-account deficit just reached that mark. It is now half again as large, as a percentage of GDP, as our previous record set in 1987, a year that saw a one-third drop in the dollar and a still legendary stock market crash. And New York Fed economists expect the current-account deficit to climb still higher.

Taking the longer view, we must also remember our creditors, notably western Europe and Japan, are aging even more rapidly than the United States. They will eventually need their savings at home to pay for their own retirement systems, which are even more costly than our own. China, another major U.S. creditor, is also aging rapidly, while also needing huge amounts of capital to finance its own industrial expansion.

Library of Congress subject headings for this publication: Budget deficits United States, Budget United States, Government spending policy United States, Fiscal policy United States, Entitlement spending United States