The Obama Budget: More Debt Makes America Weaker

If you’ve been following congressional hearings about the near collapse of America’s financial system, then perhaps you have already figured out why both political parties were so blind to the danger. They were blind because they did not want to see. Anyone who cared to look could see something was not right with the way risks were being measured, but it was more rewarding to act like everything was fine. Having now indulged in two years of partisan recrimination over the resulting financial crisis, the political system is ready to embrace its next big delusion. The Obama Administration is providing the foundation for that delusion today, in the form of its fiscal 2011 budget request.

The new delusion is that America will be made healthier and safer by continuing to borrow over a trillion dollars annually, mostly from foreign nations, even though we know the federal government would be insolvent within months if those nations decided to stop accepting the Treasury’s I.O.U.s. This delusion has taken hold because facing the reality that we are in grave danger due to our dependence on cheap credit from other nations would require big tax increases and cuts in federal spending. Politicians know such steps might result in them losing the next election, so instead they prefer to believe ridiculous things about the countries that buy our debt — especially the biggest lender, China.

Here are a few of our cherished misconceptions about China. China will continue covering hundreds of billions of dollars in U.S. debt each year even though the obligations it acquires pay almost no interest. China can’t cut America off without hurting its exporters and sparking a trade war. China has nothing better to do with the two trillion dollars in exchange reserves it has accumulated than buy U.S. debt. China is not the only lender to which America can turn, and other countries or institutions can be induced to lend us more money. If you believe any of these things, then you too are living the dream — a dream from which we may soon awake to discover the nation is facing its third financial crisis in a dozen years.

My colleague Dan Goure has noted how similar the emerging Obama defense posture is to that of the Bush years. What relatively few observers have noticed is how similar the Obama attitude is towards fiscal discipline. Apparently, the administration intends to go on spending $3-4 billion per day that it does not have, expecting to place all the debt globally at very low rates of return, without suffering any serious consequences. Since most of the debt is in relatively short-term instruments, it wouldn’t take long at all before a spike in interest rates drove the annual carrying cost of the federal debt to unprecedented levels (say, a quarter of the budget, or a trillion dollars per year in interest payments). And a spike in interest rates is just about the most benign consequence we could expect if China decides it has enough of our I.O.U.s.

This is not the behavior of a political system with a bright future. Somehow, America has backed into an era when two seemingly different political parties are locked in a collusive relationship that requires each one to drive the nation deeper and deeper into debt. They both know what they are doing, but they have each generated self-serving rationalizations for why they aren’t really destroying America. The National Intelligence Council captured the result in its first big briefing to President Obama: “In terms of size, speed, and directional flow, the global shift in relative wealth and economic power now under way — roughly from West to East — is without precedent in modern history.” It’s too bad, especially for our kids, that Obama didn’t listen.