March 2007
The End of the World As We Know It?
By Michael Anderson

Peter Peterson’s talk at SAIS on February 6 provided a sobering look at the future of the American economy. Peterson, a successful investment banker and lifelong Republican, focused on the ‘quad-deficits’: long term budget deficits, current account deficits, savings deficits, and a political or leadership deficit. If you plan on being in any way connected to the global economy after graduating from SAIS, then pay attention to these excerpts from his speech.

Long Term Budget Deficits:
Over the next 10 years, the Social Security surpluses of $1 trillion reduce the apparent size of the deficit but, in about 2017, Social Security goes in the opposite direction: from large surpluses to increasingly large – indeed huge – annual deficits ($267 billion, in today’s dollars, in 2030 for Social Security alone). Unfunded Social Security and Medicare obligations are $39 trillion in today’s dollars (this is the lowest of the official estimates) and include over $350,000 of hidden off-the-books debt for every American household. The projected increase in entitlement spending between 2000 and 2040 is 9% of GDP. Just the increase is nearly three times what we have been spending on defense. The Concord Coalition, using reasonable projections, projects that entitlement and interest alone are expected to consume all federal revenues in under 20 years. All of this evidence of the coming metastasis of entitlement spending makes clear why failure to deal with entitlements would decimate other cherished federal programs. Perhaps this crowding up process has already begun. For example, in the increasingly competitive world economy, there is agreement that more investment in government supported basic R&D is imperative. Yet, as the entitlement has mushroomed, this investment in basic R&D has shrunk from 5% down to 2% of the federal budget.

Chairman Ben Bernanke recently reminded Congress – and the public – that in less than 30 years public debt as a percent of GNP would grow to 100%, and that the only time in U.S. history that has happened was in World War II. He also reminded us that the budget deficit would approach an unthinkable 9% of the GDP. So, over the longer term, the easy notion that we are now on the path to balanced budgets is truly delusional. Occasionally, I hear someone say: Perhaps we can grow out of these problems. To grow out of our entitlement obligations, the comptroller general of the U.S. – you might say the chief accounting and auditing officer – has said that, under what he considers plausible assumptions, it would take double digit, indeed as much as 20%, annual real inflation adjusted growth over the next 75 years.  Considering that over the last 30 years, we have averaged about 3% growth, any idea of growing our way out of these problems is a fantasy.

There is another much bigger elephant in the entitlement boudoir that we pretend not to see and hope that no one else is rude enough to point it out: Medicare. Medicare’s unfunded liabilities are over five times bigger than Social Security. And Medicare’s costs are projected to increase over three times faster than Social Security. Social Security and Medicare together will account for about 38% of our children’s payroll.

Current Account Deficits:
The previous record account deficit in the 1980’s was 3.45% of GDP. Today it’s nearly 7% of GDP (and widening by every account). Given our pathetically low net national savings rate, we have become dangerously dependent on foreign capital, on the order of $8 billion every work day, not only to finance current account deficits but also to finance over half of our critically needed domestic investments. Already, in last 20 years, we have gone from the world’s largest creditor to the world’s largest debtor. And what of the cumulative effects of such unprecedented current account deficits on our projected levels of foreign debt?  Bill Cline, a leading expert at IIE, projects that our net international liabilities would soar from 25% of the GDP in 2006 to 75% by 2016 and 145% by 2026. Paul Volcker thinks that there is a 75% chance of a dollar crisis within five years.

Beyond turning our budget deficits around, we will generally also need to consume and import relatively less and save and export relatively more, and in turn our trading partners, many of them with a current account surplus, will need to do the opposite and thereby stimulate their own domestic demand rather than relying on exports to the United States for that growth. But make no mistake about it, these changes will take time and will be difficult. Some would say they require fundamental changes in global cultures, values and politics.

Savings Deficit:
Virtually every economist I know is very concerned about the precipitous drop in the national savings rate. We Americans have gone from being among the biggest personal savers in the world to the lowest, from about 8% of disposable income in 1982 to over a 1% negative savings rate. Side-by-side with our consumption and savings behavior is our propensity to borrow.

Take the example of the housing market, where people are essentially using their houses as ATM machines. Given low interest rates and high levels of debt, people are assuming that housing prices will continue to go up and interest rates will remain low. But given that households are highly leveraged, that energy costs remain at high levels, that there are long term inflation fears, and the potential for a decline in the dollar and a related increase in interest rates, what might be the effect of a significant rise in interest rates and a significant decline in housing values on consumer spending and the US economy?

Political Leadership Deficit:
In all my years of observing developments in our political economy, I have never seen so many challenges that I would describe as undeniable, unsustainable and untouchable, politically speaking. These challenges have something else in common: we would all have to give up something for the general good. And these days, giving up something, whether spending less or taxing more, is not only considered politically incorrect, but often politically terminal. We want it all.  We want it now.  And we don’t want to give up anything. So, our political leaders either live in a state of denial, or a kind of disingenuous silence, or they try to anesthetize us. Beyond the examples I discussed earlier, our energy gluttony (and its first cousin global warming) would be another. With less than 5% of the world’s population, we consume 25% of the world’s oil. We import $300 billion of oil or more annually, from some of the most unstable and unfriendly sources in the world.

If Americans understood the truth and felt the required sacrifices were fairly shared, I have faith they would respond. So, by whom and how is that message to be delivered? Obviously, at the Federal level, and most importantly, we need a President who by his own example is honest, credible and persuasive as he not only defines the problems but as he also proposes essential and fairly shared sacrifices, whereby we are all asked to give up something to pay for it. Second, it is obvious that the process must be bipartisan. I believe the entitlement challenge is sufficiently daunting that any Bipartisan Commission should include America’s very best and most respected citizens – like Alan Greenspan, Bob Rubin, Paul Volcker, Sam Nunn, Warren Rudman and so on.  Americans who, when they speak, people listen. But there is also a critical role for those of us in the private sector. Let’s start with those of us in business. If we in business don’t involve ourselves out of genuine concern, shouldn’t we at least do so out of collective self-interest? Is it romantic to imagine there were ever many corporate statesmen?  My memories return to the years just after World War II.  The world was overwhelmed by colossal challenges, both domestic and international.  Abroad, we were trying to rebuild a shattered world economy, devoid of rules or institutions. A tiny bipartisan band of business leaders formed the Committee for Economic Development.  Recall that the 1930s had been defined by a depression, isolationism, and beggar-thy-neighbor trade wars.  In retrospect, the list of initiatives undertaken by this hardy band is breathtaking:  The Employment Act of 1946, the Bretton Woods institutions, and Marshall Plan. When the Marshall Plan was announced, only 14 percent approved.  Then these business leaders went to work and recruited other CEOs, who helped lead a massive public education effort.  Eventually, America changed its mind.

Then, of course, each of us: parents, grandparents, and most certainly the young (it is after all their future that is so seriously threatened) have a responsibility to contribute in whatever ways seem appropriate. My generation was preceded by a generation  that confronted, overcame, and paid for challenges even more sobering than today’s. They remembered what the German theologian, Bonhoeffer said, “The ultimate test of a moral society is the kind of world it leaves to its children”. We, too, must now become worthy and moral ancestors.