President Obama is receiving congratulations for moving to the center on the tax agreement with Republicans. The truth is that the deal moved us closer to a fiscal crisis, just as the eurozone now is experiencing.
The central conceit behind official thinking about fiscal policy on both sides of the aisle is that investors will buy almost all U.S. government debt without blinking an eye or increasing Treasury yields. This is an endearing and heartwarming notion.
What it should do is force us to think about how much the world has changed and how antiquated such ideas are today.
The United States is steadily losing its global economic and financial predominance. To be sure, we offer the largest amount of government debt on the market, but investors have plenty of choices around the world, both in terms of debt and other assets. The idea that our Treasury market will be buoyed by captive investors, whether the Chinese central bank or anyone else, is quaint and at odds with today's reality.
Remember that we run a large current account deficit, so we need to take in new foreign capital every day just to maintain our lifestyle. So this isn't just about foreigners refusing to understand the American debt dream.
The key to debt sustainability isn't how much revenue the government can raise relative to gross domestic product or some other economic characteristic. It's whether a country has the political will to raise taxes or cut spending when under pressure from the financial markets.
This is where Greece and Ireland were found wanting in 2010; we'll see how Portugal, Spain, Italy, Belgium and perhaps even France do in 2011. Then it will be the turn of the United States.
The issue isn't whether we can muster a bipartisan consensus to cut taxes; this is easy to do. But can our politicians agree on what to do when 10-year Treasury yields surge, interest payments soar and there are concerns about the rollover of our relatively short-term government debt?
One response is: The Federal Reserve won't let this happen and will use another round of quantitative easing or some other innovation to hold down long rates. Maybe so, but 10-year benchmark rates have spiked in the past month or so, and mortgage rates — presumed to be the Fed's target — have gained more than half a percentage point from recent lows.
At this point, we will have only two choices: Raise taxes or cut spending. Given that the Obama administration is unprepared for this scenario, and has no sensible tax-reform plans under way, this gives an opportunity to Republicans intent on big spending cuts. For anyone hoping to "starve the beast," this will be a historic oppor-tunity.
But there's a problem. The U.S. government doesn't take in much tax revenue — at least 10 percentage points of GDP less than comparable developed economies — and it also doesn't spend much except on the military, Social Security and Medicare. Other parts of government spending can be frozen or even slashed, but it just won't make that much difference.
That means older Americans are going to get squeezed, while our ability to defend ourselves goes into decline.
Just because there's a bipartisan consensus on an idea, such as tax cuts, doesn't mean it makes sense. Today's tax cutters have set us up for tomorrow's fiscal crisis and real damage to U.S. national security.