Growing debt makes Obama's economic task tougher

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By Dan Steinbock (China Daily)
Updated: 2009-09-09 07:53

When US President Barack Obama assumed office, he faced the most serious economic and financial crisis of any president since Franklin Roosevelt. In order to address the deep and severe crisis he inherited, Obama started from two main premises.

The most immediate priority was "to rescue the economy by restoring confidence and breaking the vicious cycle of economic contraction and financial failure", said Lawrence Summers, Obama's key adviser on economic policy, in July. "Second, the recovery from this crisis would be built not on the flimsy foundation of asset bubbles but on the firm foundation of productive investment and long-term growth."

During the past eight months, the Obama administration has resorted to extraordinarily aggressive measures to rescue and begin rebuilding the economy.

With its first goal, the administration has achieved significant progress. With its second goal, the future is murkier.

The numbers tell the story. According to US Congressional Budget Office (CBO), the federal budget deficit for 2009 will be $1.6 trillion. At more than 11 percent of GDP, it is the highest since World War II.

America's soaring deficit is driven by weak revenues and rising spending associated with the global economic downturn and financial turmoil. It has been boosted by a wide array of federal policies, including the stimulus legislation and aid for the financial, housing, and auto sectors.

While most private sector economists now believe that the US recession has ended or will end soon, CBO anticipates a relatively slow and tentative recovery. Economic growth will be restrained by a number of forces, including global economic weakness, continued strains on financial markets, and households' need to rebuild their savings.

With recovery, the deficit will shrink but still remain more than $500 billion a year. That is more than 3 percent of GDP through the 2010s, assuming that current laws and policies remain in place.

By the same token, public debt will grow. In 2001, the debt was 33 percent of GDP. By the end of this year, it is expected to soar to an estimated 54 percent and grow to 68 percent of GDP by 2019. The deficit is expected to soar, too, to more than $9 trillion.

Coupled with rising interest rates, the accumulating federal debt would mean a near tripling of net interest payments (relative to the size of the economy) through the 2010s.

The reality may be worse because even these projections are based on a so-called baseline scenario, which implies that many policy adjustments that lawmakers have routinely made in the past will not occur.

Assuming that such changes do occur, it is possible to outline a more realistic scenario.

Under the spending and revenue policies incorporated in this alternative scenario, federal debt is projected to surpass 100 percent of GDP by 2023. CBO Director Douglas W. Elmendorf has called such fiscal trends potentially explosive.

On Aug 21, Federal Reserve Chairman Ben Bernanke said that, despite substantial progress, "strains persist" in many markets. The credit is not flowing adequately to ensure a sustainable recovery.

While banks are not willing to lend, households are not eager to borrow. The former are coping with a risky economic landscape. The latter are burdened with enormous debt.

Despite the presumed recovery, the Fed continues to hold short-term interest rates at 0-0.25 percent - the lowest level in the US history. And in the past year, securities and other assets on the Fed's balance sheet have more than doubled to $2.08 trillion.

From Bernanke's standpoint, the priority is to avoid a double-dip recession, whereas the risk of inflation - under the present conditions - is perceived as less of a threat.

In the long-term, almost all projected growth in federal spending, other than interest payments on the debt, comes from growth in spending on healthcare (Medicare, Medicaid) and social security.

In order to make a strong and sustainable recovery, the Obama administration thus needs to implement a broad change program, which extends from the deficit to healthcare. The question is: Will Americans continue to support the administration in this highly complex balancing act, which requires difficult choices and tradeoffs?

For success, Obama needs relatively high favorability and job performance ratings, including the support of the administration's economic policy and the way it is tackling the deficit and healthcare reform.

Yet, as the White House has been determinedly rescuing the US economy, its support has been eroding among Americans over the past eight months.

When Obama entered the White House in January, three out of four Americans had a favorable opinion of the new president. Today, his favorability rating is about 55 percent, while his unfavorability rating has almost doubled to 40 percent.

At the beginning of his term, more than half of all Americans approved the way Obama was handling the federal budget deficit. Today, the administration's deficit policy divides the nation.

Obama's plans seek to reduce long-term deficits tied to the soaring costs of the primary entitlement programs. This is vital because federal spending on Medicare and Medicaid combined is projected to double from 5 percent of GDP today to almost 10 percent by the mid-2030s.

The current debate on the healthcare reform has divided Americans. Nobody would like to take the political responsibility for difficult economic choices.

Obama inherited the worst US economy since the Great Depression but his support has eroded. Still, in order to sustain their leadership, Democrats need strong economic performance in 2010 to win the Congressional elections.

Significant policy adjustments are needed to put the US budget on a sustainable course. The costs of postponing action are prohibitive.

The question facing America is no longer whether to address the issue of rising deficits and debt. The point is to tackle them as soon as possible and to develop a consensus on how to do it. And that's easier said than done.

The author is the research director of International Business at the India, China and America Institute.

(China Daily 09/09/2009 page9)