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 not.

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 growth.

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.

__________________
AMERICA LAND OF THE FREE HOME OF THE BRAVE--BECAUSE OF OUR CONSTITUTION.