These realities aren't news, although the Bush administration's policies of massive tax cuts and increased spending on all fronts made these underlying problems substantially worse. Recent developments, however, have made ignoring the situation much harder.
The deficits projected over the next 10 years will accelerate our arrival at a debt-to-GDP ratio that for most countries would signal impending fiscal collapse. Indeed, Britain, with a debt-to-GDP ratio not appreciably worse than ours, was just warned by Standard & Poor's that its creditworthiness might be downgraded. The United States has traditionally enjoyed a favored status in this regard, as the supplier of the dollar, the world's reserve currency, and as a perceived haven in times of financial stress. But for how long?
In March, Chinese Prime Minister Wen Jiabao publicly questioned the safety of U.S. Treasury debt. Over the winter, prices in credit-default swap markets implied a significant probability of default on U.S. debt in the next five years.
Default on national debt is what happens in failed states and banana republics; such a possibility for the U.S. would have been unthinkable in the past.
All of this will finally force difficult choices on policymakers. Healthcare reform, for example, is crucial if we're to fix entitlement programs. But it alone won't be enough. Spending will have to drop, and taxes will have to rise. And the choices could get harder still. If the economy recovers very slowly, those decisions will need to be faced in the context of a weaker economic situation with demands for further fiscal stimulus.
In the immediate future, policymakers will face a delicate balancing act between encouraging economic recovery and establishing fiscal sustainability. Short-term stimulus can boost an otherwise weak economy, so withdrawing stimulative policies and imposing fiscal discipline too soon could slow the recovery. But delaying fiscal discipline too long could be equally destructive. Success will take new ideas, some luck and uncharacteristic honesty and resoluteness -- from our leaders in Washington and from the rest of us.
