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Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It
Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It
Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It
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Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It

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When Bush came to office in 2001, the 10-year budget balance was officially projected to be at a surplus of $5.6 trillion. But after three big tax cuts, the bursting of the stock-market bubble, and the devastating effects of 9/11on the economy, the surplus has evaporated, and the deficit is expected to grow to $ 5-trillion over the next decade. The domestic deficit is only the half of it. Given our $500 billion trade deficit and our anemic savings rate, we depend on an unprecedented $2 billion of foreign capital every working day. If foreign confidence were to wane, this could lead to the dreaded hard landing.

Peter G. Peterson--a lifelong Republican, chairman of the Blackstone Group, and former secretary of commerce under Nixon--shatters the myths with hard facts and a harrowing view of the twin deficit's real impact. Republicans and Democrats alike have mortgaged America's future through reckless tax cuts, out-of-control spending and Enron-style accounting in Congress. And the situation will only get worse as the Baby Boom generation begins to retire, making unprecedented demands on entitlement programs like Social Security and Medicare. Despite what Bush says, we are on a path that could end in economic meltdown, and we simply cannot grow out of the deficit.

In Running On Empty, Peterson sounds the warning bell and prescribes a set of detailed solutions which, if implemented early, will prevent the need for draconian measures later. He takes us behind the politicians' smoke-and-mirror games, and forcefully explains what we must do to rescue the future of our country.

LanguageEnglish
Release dateAug 1, 2004
ISBN9780374704919
Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It
Author

Peter G. Peterson

Peter G. Peterson is the author of Gray Dawn: How the Coming Age Wave Will Transform America--and the World. He is chairman of The Blackstone Group and chairman of The Council on Foreign Relations.

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  • Rating: 5 out of 5 stars
    5/5
    A must read for anyone concerned about the budget deficit.
  • Rating: 4 out of 5 stars
    4/5
    A good read for anyone who cares about the future of the American economy. A look at how Bread-and-Circuses economic strategy steals from our future and why politicians have a vested interest in denying the problem. But don't throw in the towel - we can still turn things around if we take a hard look at wear we are heading, gird out loins, and do what it takes (suggestions included).

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Running on Empty - Peter G. Peterson

PREFACE TO THE NEW EDITION

Much has happened since this book went to press in the spring of 2004. The cyclical recovery of the U.S. economy has gained steam, with housing and consumer goods showing special strength and with rising global energy prices emerging as a new worry. Leaders in Europe and Japan are beginning to express alarm at the slow pace of their own recovery. In the Mideast, popular protests mingled with ongoing terrorism raises the odds that the U.S.-led war on terror will be engaged there for years to come. Meanwhile, in one of the : most rancorous elections in living memory, President George Bush defeated his Democratic challenger. He has entered his second term brimming with unexpected energy on fiscal policy, vowing to reduce the deficit, and at long last to reform Social Security.

Yet beneath all the trends and events the old French proverb still prevails: The more things change, the more they stay the same. Just about every major political theme examined in this book has replayed itself like a looped CD in recent months, from more culture-wars partisanship (during the 2004 campaign season) to more fanciful forecasting (in the President’s FY 2006 deficit targets) to more willful ignorance (among Democratic leaders who still insist that Social Security is sustainable as is).

Indeed, the central policy challenge remains as urgent as ever—how to get America to borrow less, import less, export more, save more, balance its budgets, repair its national balance sheet, and lift the burden of unaffordable public promises off the shoulders of today’s young people.

The fundamental fiscal issue is the need to make difficult choices, declared Fed Chairman Alan Greenspan earlier this month, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age … The likelihood of escalating unified budget deficits is of especially great concern because they would drain an inexorably growing volume of real resources away from private capital formation over time and cast an ever-larger shadow over the growth of living standards. Even the tone of such warnings has not changed much—nor, alas, has the willingness of leaders to listen or simply talk straight to the American people. The temptation to buy votes from boomers and seniors by piling massive unfunded liabilities on future generations ($74 trillion at last count) seems hard to resist. According to humorist Dave Barry, it’s like going to a fancy restaurant and ordering everything on the menu, secure in the knowledge that when the bill comes, you’ll be dead.

To gauge the magnitude of this policy challenge, I refer more than once in these pages to America’s twin deficits—the U.S. federal budget deficit and the U.S. current account deficit. The budget deficit tracks the chronic borrowing gap between what Americans give to government and what they get from it. The current account deficit tracks how much more Americans spend than they produce; this is what they have to borrow from foreigners in order to sustain their excessive consumption. I refer as well to America’s third or triple deficit—namely, our overall national savings deficit. This is the bottom line. If American households and businesses were prodigious savers, the other two deficits wouldn’t be so worrisome. But clearly we’re not. We’re poor savers, and over time we’re getting worse.

Let’s take a closer look at our most recent savings performance. In 2004, for the third year in a row, the U.S. net national savings rate will fall beneath 2.0 percent of GDP That is less than half of the average rate for the 1990s (4.5 percent), less than a third of the average for the 1980s (6.2 percent), and less than a fifth of the average for the 1960s and 1970s (9.9 percent). The three years since 2001, in fact, have all been lower than any prior year going back to 1934, in the depths of the Great Depression.

Yes, large federal deficits—negative savings, really—are helping to push down total national savings. But the U.S. net private-sector savings rate has also been falling to the lowest annual level since the 1930s. Personal savings rates tell a similar story: In 2004, Americans saved 1.2 percent out of their personal income—yet again, the lowest annual rate since 1934. Household debt, as a percent of disposable income, has risen to 16 percent, the highest level in two decades. Credit card debt now averages an astonishing $8,000 per household. Facing an impending and utterly predictable age wave, Americans today ought to be saving more. Boomers especially ought to be preparing for the extra personal and public costs that will accompany the swift rise in the ratio of elder consumers to younger workers. Instead—buoyed by rising home prices, low interest rates, tax-deductible home equity loans, ceaseless credit card solicitations, and reassurances from political leaders that we can keep lowering taxes while preserving more benefits—we are all going on a binge.

An occasional critic will argue that conventional savings rates are misleading because they don’t measure human capital and don’t reflect market value. Though I will grant that conventional methods are imperfect, the measurement bias can’t be large enough to change the overall picture. It’s hard to see, for instance, why the bias should cause all of these conventional rates to be lower in the United States than in other major economies, or why it should cause all of them to decline over time. Education and research and development are critical, but few would contend (especially with federal cutbacks) that we are investing vastly more in these areas than in previous decades.

As for market value, let’s not get sidetracked. We need more usable savings, not value that’s locked up in home prices or corporate valuations. We need funds that can be invested in new capital projects and to cover our twin deficits. No economy can indefinitely add to its capital without at some point consuming less than it produces. Adam Smith might usefully be invoked here: As the capital of an individual can be increased only by what he saves from his annual revenue, he wrote, so the capital of a society .. can be increased only in like manner. Note that the patron saint of modern economics did not say that a society can save by consuming all of its income while riding up a stock-market bubble or housing boom.

Countries that undersave face a stark choice: They can underinvest in productive capital and so rob future workers of productivity, and wage gains, or they can borrow from abroad, buy the new capital, but incur an ever-rising debt-service charge for what they borrow. Lately, the U.S. has opted heavily for the borrowing-from-abroad strategy.

This brings us to our current account deficit. In 2004, net U.S. borrowing from the rest of the world (plus net U.S. asset sales to the rest of the world) came to an estimated $666 billion. That’s an annual savings inflow of roughly 5.7 percent of GDP, a figure never before reached in U.S. history. As of this month, it is still heading upward and is approaching twice the previous record in the 1980s, just before the dollar fell by a third.

Effectively, this foreign inflow finances over four-fifths of U.S. domestic net investment. It also finances a growing share of U.S. Treasury debt and of federally guaranteed mortgage and college loans—meaning that a lot of us can thank a bondholder in Berlin or Beijing or Tokyo for the home we own or the education we enjoy. At the end of 2004, foreigners (central banks, especially) held 44 percent of publicly held Treasury debt, up from only 19 percent ten years ago. No leading economy—and certainly no country with a reserve currency—has ever incurred these levels of foreign debt. I explain in this book why current-account deficits of this magnitude are not sustainable for long, both because we cannot afford ever-rising debt service payments and because there is a limit to the amount of dollar assets the rest of the world is willing to accumulate.

To be sure, this teetering and giant global imbalance—this unhealthy symbiosis—is not entirely America’s fault. Many other nations find it as convenient to save and lend (which stimulates demand for their exports and provides jobs) as it is for us to consume and borrow (which allows us to invest without the bother of saving). Unfortunately, this shared interest of governments in maintaining the status quo simply compounds the peril. Every major economy has a near-term incentive to avoid any adjustment. Yet the longer we and they fail to reverse course in a coordinated fashion, the more likely it is that the adjustment will be late and sudden, with a steep decline in the dollar, a big hike in interest rates, nasty effects on financial markets, and a prolonged and painful period of economic stagnation thereafter.

Remember that the substantial majority of the roughly $12 trillion of foreign dollar holdings are in private foreign hands. Foreign governments often focus on pursuing their domestic economic objectives, keeping their currencies weak to maintain competitiveness and export jobs. On the other hand, private investors are motivated by the likely future value of their holdings. If the private holders think these deficits are unsustainable and therefore that the dollar is likely to decline much further, many will race each other to the exit.

Some say that low interest rates and a buoyant stock market are a sign that such worries are overblown. I continue to believe that they are instead a sign of danger, like the building of seismic tension that one hopes will not be released all at once.

Just as America’s trading partners are vulnerable to a further fall in the dollar, so too is America unprepared for a sharp interest rate hike. Such a hike would bite quickly, wreaking special pain on those who have recently embraced shorter-term borrowing. Nearly half of all mortgage applications are now for variable rate mortgages. Over half of 2004 corporate bond issuances have been at floating rates. The average maturity on U.S. Treasury debt is the lowest in twenty years. Of all of the issues left undiscussed in the 2004 Bush-Kerry debates, the most glaring omission was the U.S. economy’s terminally dysfunctional relationship with the rest of the world. There was much talk about the outsourcing of American jobs. There was no mention of a more serious issue—the outsourcing of American thrift.

Now let’s turn to recent developments in the fiscal deficit, the deficit that voters and leaders most directly control. At first glance, we see something surprising here: a re-elected President who proposes a turnaround in fiscal policy. While first-term Bush opened the floodgates on federal spending and broke every deficit record, second-term Bush is announcing a new theme of spending restraint and is saying he will take the steps necessary to achieve our deficit reduction goals.

Unfortunately, this hype is not backed by much substance. On the positive side, the 2006 budget does show that this administration is willing at last to stand up to powerful spending constituencies, from the farm lobby to the vet lobby. The White House is daring to earmark ninety-nine programs for elimination and another fifty-five for major reductions. It is talking tough to state governors about Medicaid spending. And it should be commended for trying to focus public attention on Social Security’s long-term cost growth, an issue most Democratic leaders have ritually ignored.

That said; the administration’s overall fiscal strategy once again shows a striking absence of balance, candor, and long-term realism. Take balance—and to be very fair here I’ll accept the White House’s own budget numbers. Over three-quarters ($138 billion) of all the five-year cuts are supposed to come from the 18 percent of outlays that are non-security domestic discretionary spending, everything from training and transportation to NASA and national parks. By 2010, this part of the budget is slated to shrink by 16 percent in real dollars.

Much less ($39 billion) is being asked of the 55 percent of outlays that are mandatory entitlements. Indeed, the same President who has yet to veto a single spending bill has declared he would indeed veto any effort to trim the massive prescription drug add-on to Medicare (adding a stunning $16.6 trillion to our unfunded liabilities) he pushed through Congress last year (at a ten-year cost of $724 billion). And nothing at all, of course, is being asked on the entire revenue side, where the administration insists on extending its whole range of tax cuts (at a ten-year cost of $1.1 trillion). It even wants to rewrite the congressional pay-go rule to exempt further tax cuts from the same procedural safeguards that apply to spending hikes.

So lopsided is this corner-squeezing exercise in fiscal restraint that it does not do much to reduce the deficit. Even with a growing economy to fill its sail, the plan can cut the deficit in half only under an arbitrary set of assumptions (requiring us, for example, to ignore the certain cost of the war on terror and the near-certain cost of providing Alternative Minimum Tax relief). Realistically, the plan will never pull the deficit under $300 billion by 2010. Expert analysts at The Concord Coalition, the Committee for Economic Development, and Goldman Sachs project that on our current path budget deficits will total roughly $5 trillion over the next ten years.

This should have been a decade of surpluses and savings to help meet the ballooning demands of the soon-to-retire boomer generation. Instead, it has become a decade of massive deficits and dissavings.

Further out, in a future deliberately veiled by the administration’s short five-year horizon, the deficit will balloon as the boomer retirement starts pushing the growth of Medicare, Social Security, and other health and pension payments into high gear. By 2025, the White House’s own long-range model projects that the government will be borrowing from the rest of the world to afford a budget that spends 85 percent of its outlays on retirement, defense, and interest. The White House lacks candor not so much for its near-term smoke and mirrors, but for obfuscating what the 2006 budget itself confesses—that our greatest fiscal challenges are the long-term unfunded liabilities of our entitlement programs. This is a vast challenge. It cannot be met by zeroing out energy labs or teacher workshops.

To be sure, the President has issued a proposal for reforming Social Security. Yet this has triggered a national debate that, if truth be told, has reflected very poorly on the leadership of both parties.

Inexcusably, the Democratic leaders have responded to the President’s clarion call not only by declining to discuss their own alternatives for reforming Social Security (opting for what Concord Coalition Co-Chair Bob Kerrey, a former Democratic Senator, calls the Do Nothing Plan), but by refusing to acknowledge there is any need for reform at all. In their eagerness to score a political victory, Democrats are self-consciously emulating the twist-arms, admit-nothing, scorch-the-earth tactics of such partisan GOP operatives as Newt Gingrich or Tom DeLay. Senator Joe Lieberman, a thoughtful reformer, has been labeled a DINO (Democrat in Name Only) by party activists—in abject imitation of the GOP’s RINO (Republican in Name Only) label. At the very least, President Bush has done the nation a service by waking ordinary Americans to the need to do more to prepare for their retirement. Democratic leaders, apparently, would just as soon put them all to sleep again.

Their excuses for inaction are weak. Some Democrats say that yes, there’s a problem, but that this problem doesn’t start until 2042, the year when the Social Security trust fund is projected to become insolvent—that is, to run out of credit. That’s a long time. If the trust fund is solid until then, they ask, can there be any reason to be alarmed? Unfortunately, the answer is yes. The Social Security trust fund is what I call a fiscal oxymoron. It should not be trusted, and it is not funded. The facts are these. Between 2008 and 2018, the program’s declining cash balance is projected to add an extra $10 billion each year to the unified federal deficit. Between 2018 and 2042, the program will wrack up total cash deficits of $5.4 trillion. (All of these are 2004 dollars.)

Doesn’t that meet our common-sense definition of insolvency? Or urgency? Well, these Democrats answer, maybe it is a challenge. But (they say) it’s a challenge for the rest of the budget, not for Social Security—since the bonds in the trust have the full faith and credit of the U.S. Treasury. Essentially, they are claiming that the program’s earmarked revenues are sacrosanct, that its trust fund is inviolate, and that its spending promises need not compete with the rest of the budget for resources.

As the reader of this book will learn, everything about this argument is wrong. Congress can raise, lower, or earmark different streams of revenue when it wishes and for any reason it wishes. They do this often for major programs, and they have done it repeatedly for Social Security over its history. Federal budget trust funds, accordingly, are mere ad-hoc accounting fictions. In the case of Social Security, the size of the trust fund is a policy accident. It is related neither to the payroll taxes workers have paid in, nor to the future benefits they expect to receive, nor to the future resource needs of the entire program. When convenient, Congress can (and has) simply-confiscated IOUs held in budgetary trust funds—IOUs that enjoy constitutional protection only when owned by citizens, not when held by other federal agencies. Indeed, Congress retains the full power to change any aspect of Social Security overnight—including benefits.

Democrats occasionally talk about Social Security as something resembling a foreign power, ready to enforce its sovereign claims over the rest of us. That’s preposterous. The truth is that Social Security is pay as you go, the same as nearly every other activity in the federal budget, from school vaccinations and border patrols to meals on wheels and weather satellites. We don’t allow walled fiefdoms within our budget. We’re all in this together. That’s why we call ourselves a democratic republic.

Precisely because Social Security is a pay-as-you-go system, we must begin to think about cash in and cash out, that is, in cash flow terms. Currently, the annual Social Security cash flow surplus, which, of course, we are spending on other government programs, runs at about $90 billion. By 2030, the annual Social Security cash flow deficit, in today’s dollars, is projected to be $250 billion.

Another argument sometimes offered by Democrats is that the projected deficit impact of Social Security isn’t a problem because the projections for Medicare are much worse—as though, when plugging a number of gushing leaks in your boat, it really matters which leak you plug first. The argument would gain credibility if these Democrats were just brimming with creative ideas on how to cut the long-term growth in Medicare spending. I’ve been listening hard, and I haven’t heard them.

The underlying claim, of course, is perfectly correct: Medicare is the much bigger cost problem. It is, if I may say so, the elephant in the boudoir that we pretend not to notice and hope no one else is rude enough to mention. How big an elephant? Earlier, I mentioned the $74. trillion unfunded liability for Social Security and Medicare. Medicare’s share of that is $63 trillion, or over 80 percent of the liabilities. Current Medicare payroll taxes would have to triple to cover the projected costs, leaving our kids with a prospect of payroll taxes of over one-third of their wages to cover the costs of Social Security and Medicare. And even that’s just the hospital insurance or Part A of Medicare. If we include payments to physicians (Part B) and payments for prescription drugs (the new Part D), the taxes will have to take over half of our kids’ wages.

Alas, Medicare is also the much tougher elephant to corral, politically and ethically. To be sure, there is plenty of waste. Most American health care (including Medicare) is paid for through open-ended, cost-plus, fee-for-service reimbursement systems in which a patient and doctor agree on how much of someone else’s money to spend. America spends over twice as much per capita as other developed countries on healthcare—and I have been unable to find any evidence that the extra spending does all that much to improve our health-care outcomes.

Yet whatever reforms are talked about—be they more use of information technology or medical malpractice reform—we must in the final analysis confront the brute fact that we are going to have to give up some medical care that may have some benefit. This will raise the dreaded R word in American politics, R for rationing. Rationing, of course, raises the daunting ethical issues of who lives, who dies, who decides, and who has the final say in allocating health-care dollars (the market, the doctor, the regulator, the legislature, or whatever). As a society, we have been very poorly prepared for this difficult but inevitable discussion.

So again, yes, the Democrats are correct that Medicare is the bigger problem. Where they go wrong is to imply that this takes the heat off Social Security. To the contrary, Medicare’s rapid projected growth explains why the imminent aging of America will pose such a great fiscal challenge—and will compel us to restrain the cost growth and eventual tax burden of every aging-related benefit program. Yes, Medicare requires far-reaching reform. But so does Social Security. And that’s the program that’s now on the table.

Now let’s return to Social Security and this time to the Republicans. Again, to their credit, the President and a handful of GOP leaders in Congress have taken the lead in pointing out, unequivocally, the urgent need for Social Security reform. Yet while many Democrats can’t make sense of the problem, many Republicans can’t make sense of the solution. Democrats say there’s nothing wrong. Republicans say there is something wrong, but that the remedy is painless. It’s hard to say which fiction is more dangerously misleading.

Personal accounts is the reigning GOP mantra on how to reform Social Security. The idea is to allow workers to divert part of their FICA taxes into personally owned accounts, which, they say, will enable workers to make up for any needed reduction in the current benefit system. Under the President’s current plan, they will be able to divert up to 4. percent of their pay. The catch, of course, is that Congress will have to borrow a dollar (to replace the lost FICA revenue) for every dollar that workers put into their accounts. Taxpayers will thus be losing money, at interest, at the same time that workers with accounts are gaining money, at interest.

But taxpayers will get all their money back, say personal account advocates, because the Social Security benefits eventually paid out to account-holders will be reduced by the extent of this borrowing. Moreover, the account-holders themselves will be better off because the rate of return on their accounts is likely to be higher than the rate of interest they are charged. This will allow us to cut Social Security benefits across the board at some future date without reducing the overall retirement income (benefits plus personal accounts) going to workers, or at least to those workers who have accounts. There you have it, the free lunch in a nutshell. By financial alchemy, a lot more benefits will come out of the system—enough to make up for the projected shortfall—without anyone putting anything more into the system.

There are glaring problems with this strategy. To begin with, it is risky, requiring the U.S. Treasury to issue literally trillions of dollars in formal debt (under the President’s plan, $5 trillion in current dollars over two decades) before the uncertain returns on personal accounts begin to make a difference. What if the accounts fail to perform as advertised, thus requiring government to borrow even more to make good on public expectations? What if future creditors at some point simply refuse to buy federal debt at a reasonable price? Like most high-leverage schemes, this one has no contingency planning. Betting on debt-financed personal accounts is like wading out in the surf to reach a sandbar. You hope you don’t drown before reaching your

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