By Paul B. Farrell, MarketWatch - Published: 07-30-07
Will Moody's downgrade America's debt next? Actually, that's already happening; our credit rating is collapsing with the dollar.
Foreign banks are dumping dollar reserves, while we gorge on , cheap toys and bad pet food. Actually, our biggest "terrorist" threat is internal: Distorted values are downgrading our nation's "creditworthiness." We're like out-of-control kids with stolen credit cards, spending our future with no plans to repay.
Recently Robert Hormats, vice chairman of Goldman Sachs (International), appeared before the U.S. House Budget Committee to "discuss an issue of great economic, financial and national security importance to our country -- the growing dependence of the United States on foreign capital." Currently we import $1 trillion new debt annually, with no repayment plans. That's a historic break from over two centuries of American policy.
Hormats was in Washington with warnings from his brilliant new book, "The Price of Liberty: Paying for America's Wars." He traces the history of American wartime financing from the Revolution through the War of 1812, the Civil War, the two World Wars and the Cold War to the present.
Conclusion: "One central, constant theme emerges: sound national finances have proved to be indispensable to the country's military strength" and long-term national security.
1776 to Iraq, national security demands fiscal responsibility
America's long tradition of war financing began with Alexander Hamilton: "In January 1790, Hamilton, by then the country's Treasury secretary, confronted the American people with a stark fact: the nation had run up a huge debt fighting the Revolutionary War. This debt, he wrote, was the 'price of liberty,' and the new government had to repay it.
The future creditworthiness of the United States, and ultimately the security and ability to finance future wars, would depend on how successfully and faithfully this was done."
Hamilton's principles have kept America's credit strong through every war since the Revolution ... until the Iraq War. Since then, "although U.S. leaders have warned that the war against terrorism could last for decades, the country lacks a multidecade financial strategy to address the challenge."
Iraq tossed the lessons of history out the window. Hormats says that despite the oft-repeated remark that 9/11 "changed everything, in the area of fiscal policy, however, it changed nothing. The country is pursuing a pre-9/11 fiscal policy in a post-9/11 world." That assessment comes from someone who worked inside Washington for over a decade before joining Goldman Sachs in the 1980s.
Unsustainable debt is weakening national security
America's new faith-based guns-and-butter policy is hurting both guns and butter. The war is costing us $12 billion a month. Hormats examined the Congressional Budget Office's projections for domestic costs: "In 2006, spending on Social Security, Medicare, Medicaid and interest on the federal debt amounted to just under 60% of government revenues" and "if they continue on their current path, they will account for two-thirds by 2015."
• Social security from $550 billion to $960 billion
• Medicare from $372 billion to over $900 billion
• Medicaid from $181 billion to $390 billion
Worse yet, these commitments will continue skyrocketing in later decades. The CBO projects the federal debt rising from 40% of GDP to 100% in the next 25 years: "Continuing on this unsustainable path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security."
Hormats warns of the risks of this gross departure from Hamilton's principles: "Of late, the precedents and experiences of past generations have been cast aside. The 9/11 attacks were seen by many legislators as a license to spend more money on non-security programs, and Americans have not been called to make sacrifices. Tax cuts and spending increased on politically popular security-irrelevant domestic programs have been enacted as if there were no expensive defense programs to be funded."
Turning point in Iraq, where 'deficits don't matter'
In my opinion, the turning point occurred in late 2002. Remember, the Afghan War was hot. America was in recession and a bear market. The surpluses of the 1990s rapidly disappeared. Corporate scandals were damaging our global standing. Washington was pushing a second round of tax cuts. And the Iraq invasion was imminent.
Treasury Secretary Paul O'Neill, true to Hamiltonian principles, warned the White House of a coming fiscal crisis. The vice president retorted: "Reagan proved deficits don't matter." (Hormats tells me Reagan never said that.) Soon after, Cheney "fired" O'Neill ... and Hamilton's principles of sound war financing were dead.
Unfortunately, Washington's radical new faith-based financing is sabotaging national security. America's unsustainable deficits are making us extremely vulnerable to terrorists whose goal is to "attack the United States, perhaps with chemical, biological, or nuclear weapons capable of killing enormous numbers of people and seriously disrupting the American economy," targeting a "major port or transportation center."
Hormats says America is now "relying on faith over experience, hoping that sustained growth will erase deficits and that the ballooning costs of Social Security, Medicare and Medicaid will be manageable in the coming decades without difficult reforms."
Yet economists now estimate these entitlements can only be "reformed" by either a cut in benefits or an increase in taxes greater that 40%. In short, today's faith-based economics is failing us.
The current Treasury secretary also appears to be supporting this new approach: Henry Paulson, former Chairman and CEO of Goldman Sachs, recently told Fortune that "this is far and away the strongest global economy I've seen in my business lifetime."
Well, that sure sounds to me like yet another rejection of Hamiltonian principles in favor of the new faith-based policy, which assumes that global economies will always be strong and, therefore, foreign capital will indefinitely bankroll America's war machine at a low cost.
The danger is, it also assumes that American taxpayers will be able to indefinitely pay the interest costs of our burgeoning foreign debt ... on top of exploding unfunded domestic entitlements in Social Security and Medicare.
Time to rediscover 'Hamilton's gift' of war financing
Hormats was being much too diplomatic in summing up his warning to the House Budget Committee: "If government debt continues to pile up, deficits rise to stratospheric levels and heavy dependence on foreign capital grows, borrowing the money will be very costly. If America remains on its dangerous financial course Hamilton's gift to the nation -- the blessing of sound financing -- will be squandered."
The truth is, America's leaders have already squandered "Hamilton's gift," and along with it, more than two centuries of experience, replacing it with a new "faith-based" policy: "Deficits don't matter."
No wonder Main Street Americans have a "gut instinct" that we're a disaster waiting to happen. Not only are we "transferring an inordinate burden to future generations," says Hormats, Washington's undisciplined spending and total lack of a financial repayment plan is undercutting our national security and exposing America to the worst-case scenario: Another domestic terrorist attack that would trigger a "massive disruption of our economy" and a meltdown of America's credit rating throughout the world.
The truth is, America desperately needs a new "Hamilton" who understands that in calculating "the price of liberty," not only do deficits matter, Americans must have a plan to repay our debts ... if we want a strong credit rating that insures our national security for future generations.
