Lenders talk about a “debtor’s death spiral.” It
occurs when borrowers get so far in over their heads
they begin borrowing money just to cover the interest
payments on past borrowings. The borrowers have to do
this to keep the lending flowing but they can no
longer plausibly pay down the principal. As new debt
compounds on old, bankruptcy becomes imminent.
Further lending is foolhardy. Foreclosure is only a
matter of time.
The U.S. is starting to look like it is entering just
such a death spiral. It is foretold not simply by the
large and growing deficits, nor by the fact that their
carrying costs will rise quickly as interest rates
rise. Rather, it is the fact that these trends are
becoming irreversible, a structural part of the U.S.
When the ultimate collapse will occur, whether it
comes with a bang or a whimper, how it will be
triggered, and how severe it will be are as yet
unknown. But as Herbert Stein, Chairman of the
Council of Economic Advisers under Richard Nixon was
fond of saying, “Things that can’t go on forever,
The first signs of impending trouble are the exploding
budget deficits themselves. They began, of course,
under the parlous economic stewardship of Ronald
Reagan. Reagan cut the marginal tax rate on the
wealthiest of Americans from 70% to 38%. He promised
it would spur an orgy of investment and rocket the
economy to new levels of production and prosperity.
Instead, his “supply side economics” did the exact
opposite. It produced the deepest recession since the
Output fell 2.2% in 1982 while budget deficits soared.
When Reagan took office in 1981, the national debt
stood at $995 billion. Twelve years later, by the end
of George H.W. Bush’s presidency, it had exploded to
$4 trillion. Reagan was a “B” grade movie actor and a doddering, probably clinically senile president, but he was a sheer genius at rewarding his friends by saddling other people with debts.
Bill Clinton reversed Reagan’s course, raising taxes
on the wealthy, and lowering them for the working and
middle classes. This produced the longest sustained
economic expansion in American history. Importantly,
it also produced budgetary surpluses allowing the
government to begin paying down the crippling debt
begun under Reagan. In 2000, Clinton’s last year, the
surplus amounted to $236 billion. The forecast ten
year surplus stood at $5.6 trillion. It was the last
black ink America would see for decades, perhaps
George W. Bush immediately reversed Clinton’s policy
in order to revive Reagan’s, once again showering an embarrassment of riches on the already most embarrassingly rich, his “base” as he calls them. He ladled out some $630 billion in tax cuts to the top 1% of income earners. In true Republican fashion, they returned the favor by investing over $200 million to ensure Bush’s re-election. Do the math. A $630
billion return on a $200 million investment: $3,160
for $1. I’ll give you $3,160. All I ask is that you
give me $1 back so I can keep the goodness flowing.
Do we have a deal? Republicans know return on
But the cost to the public has been a return to the
exploding deficits of the Reagan years. Bush blew
through Clinton’s surplus in his first year. The 2004
deficit reached $415 billion, a record. Still, its
real size is masked by the fact that Bush has shifted
$150 billion from the Social Security trust fund in
order to make the shortfall look smaller. It’s like
pretending you’re richer when you move money from one
pocket to another. Both sums have to be repaid, so
the real amount borrowed is the $415 billion “nominal”
deficit plus the $150 billion from Social Security or
This shell game with federal trust funds taints all
official forecasts about Bush’s deficits going
forward. For example, the Congressional Budget Office estimates Bush’s cumulative ten year deficit at $2.3 trillion, to be sure, a breathtaking shortfall from the $5.6 trillion surplus he inherited from Clinton.
But as with the yearly number, this one ignores the
trust fund sleight of hand, an omission of some $2.4
trillion. When this is added back in, Bush’s ten year
deficit leaps to $4.7 trillion, $10.3 trillion short
of Clinton’s number.
But even that number is understated because the CBO
forecasts are based on current law. Bush’s tax cuts
have not yet been made permanent. If Bush is
re-elected and the cuts are made permanent, that would
add another $3.2 trillion to the shortfall. It was
not too long ago that a $3.2 trillion increment to
anything would have made sober people’s noses bleed
but such figures are mere accounting details to the
Big Thinkers in the White House, especially since it
will not be their constituents who are paying it back.
Add it all together—the “nominal” deficit, the stealth siphoning from Social Security, and the permanent effects of Bush’s tax cuts—and the 10 year deficit explodes to a mind-boggling $7.9 trillion. Within ten years, the government will owe more than $15 trillion. And this, at precisely the time the government needs fiscal solvency to begin paying the Baby Boomers their Social Security.
This run-up in debt represents the most rapid,
predatory looting of public wealth in the history of
the world. The interest costs alone will consume the
government and, soon, the entire economy. In fiscal
2004, interest costs came to $321 billion against a
deficit of $415 billion. So three quarters of all the
current year borrowing is spent paying interest on
past borrowing. This is the most immediate symptom of
the deficit death spiral.
And the situation will only get worse when interest
rates rise, as they must. The U.S. has enjoyed an unprecedented period of low rates, the lowest in 50 years. The only direction they can go is up. And they will rise quickly once foreigners, who are more and more the buyers of U.S. debt, become saturated with dollars and begin to eschew additional lending.
This is effectively what happened in the early 1970s
when the Arab oil sheikdoms realized that Nixon had
decoupled the dollar from gold redemption but was
still paying for oil in dollars—essentially paper.
The sheiks tripled the price of oil in 1973 and again
in 1978. The OPEC “oil shocks” wrought havoc on the
American economy, putting a death to the halcyon days
of post-World War II economic growth. Today’s oil at
$50 a barrel is the modern day enactment of the same
implicit disdain for dollars.
The Japanese did the same thing in 1987. For years
they had funded Reagan’s massive supply side budget
deficits but had been made fools as the dollar was
losing 15% a year in value, more than wiping out the
5% return they were receiving on their treasuries.
They wisely stopped buying in October 1987,
precipitating the greatest one-day U.S. stock market
collapse since the Great Depression.
The “dollar overhang” problem caused by Bush’s record
budget deficits is compounded by record U.S. trade
deficits. Every month, the U.S. economy buys some $50
billion more from the world than it sells, in the act
flooding the world with private dollars. These are on
top of the public dollars from the budget deficits.
The total trade deficit for 2004 will amount to some
$680 billion. As recently as 1992, the amount was
only $34 billion, a twenty fold increase in just over
10 years, another sign of the spiral.
These “twin deficits”—trade and budget—combine to well
over $1 trillion a year of borrowing. Their effect is
to bury the world’s economy in dollar debts, dollars
that increasingly buy less and less. As mentioned
above, no one knows when the world will say, “enough.”
Japan holds a reported $1 trillion supply of dollars,
China, more than half a trillion. Both have bought
dollars—in effect loaning equivalent sums to the
U.S.—in order to keep the value of their own
currencies low and therefore make their own goods
cheaper in American markets.
The Bush administration claims that both countries
will continue to buy dollars so that their own
currencies will not rise. But the danger is that once
one major player declares it doesn’t want any more
dollars there will be a rush for the exits. Demand
for dollars, and with it, the dollar’s price, will
plummet. The last player holding dollars will be
stuck with the bag, a multi-trillion dollar stash of
dollar holdings that are worth only a fraction of what
they were just a month before.
In other words, there are structural incentives
biasing the descent toward chaos rather than order.
Already, the dollar is down 19% over the past year, an
eerie harkening of the Japanese experience of the late
eighties. Its decline is being cagily “managed” by
the U.S. Treasury which has muscled foreign central
banks into picking up the slack since private foreign
buyers have begun to refuse further dollar purchases.
Foreign central banks now hold some 40% of total U.S. government debt.
The only way the U.S. government can prevent a
stampede is to raise interest rates—the return for
holding dollars. And Alan Greenspan has begun this
process. But this, of course, increases the carrying
costs of the national debt. As if a $7 trillion
national debt funded at 4% isn’t bad enough, envision
a $15 trillion debt at 10%. Instead of $300 billion a
year in interest costs, think of $1.5 trillion.
Instead of interest amounting to 3% of GDP, imagine
the carnage as it approaches 10%.
The higher rates will put a knife in the heart of an
already tenuous recovery, undermining the only process
by which payoff might ever be accomplished. It will
suck all of the oxygen out of the economy. Economists
call this the “crowding out effect” when lending to
the government gets priority over private lending.
After all, government has the power to tax in order to
fulfill its obligations whereas private borrowers do
But the market rations shortages by raising
prices—interest rates—forcing private borrowers to pay
ever more for scarce capital. In this way, markets
for private debt mirror markets for public debt.
Investment, the foundation of future growth, will be
savaged. New roads, hospitals, factories, schools and
research will be sacrificed to escalating interest
rates borne of stratospheric debt.
This occurred during the deficit-burdened 1980’s when investment grew at an annual rate of only 2.5% versus 6.9% in the surplus-graced 1990’s. And not surprisingly, productivity suffered as well. It grew at a meager 1.4% per year during the 1980’s but almost 50% faster, 2.0%, during the 1990’s.
This is the perverse, inescapable cycle—the death
spiral—that comes part and parcel with too much debt.
Its relentlessly rising carrying costs steadily erode
the possibility of getting out from underneath it.
Higher debt loads lead to higher interest rates, which
lead to lower investment which leads to slower growth
and, ultimately, diminished prosperity. And it
develops a runaway, recycling dynamic all its own.
Finally, it is not only the high absolute levels of
debt, nor their rapid expansion, nor even the
imminence of much higher interest rates that consign
the U.S. to the certain oblivion of a deficit death
spiral. It is that this toxic combination of
circumstances has become structural, irreversible,
locked into the very nature of government economic
policy. It is like a driver hurtling down a cul de
sac and gluing his foot to the accelerator.
The very purpose of the Reagan supply side tax cuts
was to funnel more of the nation’s wealth to those
already wealthy. This is what David Stockman,
Reagan’s Budget Director, meant when he called them a
“Trojan Horse.” And they did their job wonderfully.
In 1980, the top 20% of income earners captured 43.7%
of all national income. By 1992, at the end of the
first Bush administration, their share had risen to
46.9%. Today it is over 49%. Meanwhile, the lowest
four fifths of all income earners have seen their
share of national income decline. The lowest
quintile’s share has shrunk from 4.2% to 3.5%. The
second lowest quintile has fallen from 10.2% to 8.8%.
The middle quintile has seen its share fall from 16.8%
to 14.8%. And the second highest quintile has
suffered a decline from 25.0 to 23.3%. It is
empirically the case that the rich are getting richer
while everyone else is getting poorer.
The problem this holds for national economic
management is that the rich consume a much lower
percentage of their income than do those who are not
rich. How many cars can you drive at one time,
anyway? The rich are also the most likely to spend
what money they do on foreign luxury goods, take
foreign vacations, make investments in foreign
countries, or just let the money sit in the bank.
The poor, working, and middle classes, on the other
hand, spend virtually everything they earn. The car
needs new tires, the kids need new shoes, the washing
machine needs fixing, they’re two months behind on the
rent and three months behind on the credit cards. In
all of these ways, income shifted through the tax code
to middle and lower quintile earners is quickly spent
while income shifted to the wealthy is not. This is
not class warfare. It is Economics 101.
It is personal consumption—spending—that generates 67%
of GDP. If more of the nation’s income goes to those
who do not consume its output, while those who do
consume it have less and less income, a structural
shortfall emerges where there is simply not enough
purchasing power to sustain GDP. GDP will ratchet
steadily downward in mirror image to the rate at which
national income is transferred upward.
The only recourse is for the government to step in to
pump up demand. This is the role the deficits play in sustaining GDP. This is why deficits exploded under Reagan, Bush I, and Bush II, all of whom cut taxes on the rich, but declined under Clinton who raised them.
Rising public deficits are necessary—in fact,
indispensable—to sustaining GDP because so much of the
nation’s wealth has been transferred from those who,
as a matter of necessity, spend it to those who, as a
matter of taste, do not.
Supply side economics (and that includes Bush’s
ill-disguised variant) rests on the repeatedly
disproved faith that investment and prosperity are
caused by giving ever more of the nation’s wealth to
the already wealthy. As long as this lunacy continues
to drive tax policy, the government will keep
expanding federal deficits. Eventually, possibly
soon, this will cause a collapse of the dollar that
can only be reversed by raising interest rates. But
that will explode the carrying costs on the by-then
mammoth debts, vitiating private sector investment.
And that will kill all future prospects of meaningful
This is the essence of the Bush budget deficit death
spiral. To be sure, the debts are an unequalled
bonanza for those few who lend the money, for they get
to do so at ever-higher rates of interest. But it is
a death sentence for all the rest of the economy.
Robert Freeman writes on economics, history and
education. He can be reached at