StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between



The National Debt and National Security

23 May 2010
Posted by Bruce Bartlett

The Washington Post has an important column today by David Ignatius on the concerns that senior members of the military have about our national debt and those of our allies. It's easy to see why this is the case from the following table. It shows two things. First, our defense spending as a share of the economy is far above our allies. As pressure to deal with our debt situation mounts, it is inevitable that there is going to be massive political pressure to cut the defense budget. Second, given the low level of defense spending by our allies, many of which are struggling to deal with debt problems worse than ours, there is no possibility that they will be able to pick up the slack if we are forced to pull back our defense commitments.

 Defense Expenditures as a Share of GDP in NATO, 2008
 
Country
Percent
Country
Percent
U.S.
4.0
Czech Rep.
1.4
Greece
2.8
Netherlands
1.4
Bulgaria
2.6
Denmark
1.3
France
2.3
Germany
1.3
U.K.
2.2
Norway
1.3
Estonia
1.9
Canada
1.3
Poland
1.9
Italy
1.3
Turkey
1.8
Hungary
1.2
Latvia
1.7
Spain
1.2
NATO Europe
1.7
Belgium
1.1
Portugal
1.5
Lithuania
1.1
Romania
1.5
Luxembourg
0.4
Slovak Rep.
1.5
Total
2.6
Slovenia
1.5
 
 
 
Source: NATO
 
One thing that occurred to me as I read the Ignatius column is that those Republicans primarily motivated by national security and foreign policy ought to be among the strongest supporters of higher taxes. If taxes are not on the table--the non-negotiable position of all Republicans today--then this will certainly mean larger and deeper cuts in defense spending when deficit reduction becomes an issue that can no longer be put off. It's simply unrealistic to think that Congress is going to impose massive cuts in domestic discretionary programs and leave national defense unscathed.
 
My national security-minded friends should also ask themselves how much longer they feel comfortable having China as the largest holder of our debt. And keep in mind that China will likely be increasing its holdings of dollar-denominated assets as euro-denominated assets have become significantly less attractive to the financially ultra-conservative Chinese. There is simply no place left except the U.S. for the Chinese to invest their vast hoard of dollars.
 
Furthermore, it's inevitable that the Chinese are going to be increasingly interested in investing their funds in things other than Treasury securities. But as they look to buy American land, businesses and other assets they are going to confront not just legitimate national security concerns, but Xenophobia as well, which will certainly sour relations between our countries.
 
It's worth remembering that our government's fiscal profligacy is mirrored by the profligacy of our citizens, who do not save enough to finance domestic investment and appear loathe to reduce their consumption in order to save more. When any nation cannot finance domestic investment from domestic savings it has only two choices: import the saving and become indebted to foreigners or reduce domestic investment, which will lead to a lower standard of living.
 
So far we have been able to import all the savings we need. This shows up in our international accounts as a trade deficit since imported goods and services are the tangible representation of the imported saving. However, the trade deficit also impedes domestic growth--net exports (exports minus imports) reduce the gross domestic product dollar-for-dollar. Thus insofar as Americans are buying imports they are reducing domestic growth. (This is not an argument for trade restrictions, for reasons I won't go into now, just a simple fact of national income accounting.)
 
Thus to the extent that the budget deficit reduces national saving and requires us to import saving to finance domestic investment, it increases the trade deficit and increases the financial power of foreigners over our affairs. Therefore, the debt and the deficit are legitimate national security concerns.
 
For these reasons, Republicans primarily concerned about national security ought to be in the forefront of efforts to raise revenues to reduce deficits, free up domestic saving for domestic investment, and reduce the importation of foreign saving and the trade deficit. But so far they are not. They remain loyal to the Republican obsession with tax cuts and a refusal to raise taxes in any way for any reason. However, I think my national security-minded friends are soon going to discover that massive defense budget cuts will necessarily be a big part of the price that will be paid for not raising revenues.
 
Addendum
 
Stephen Bainbridge apparently thinks gutting the defense budget is preferable to raising taxes by a single penny.
 
Note: since I posted this addendum Stephen has amended his original post to make it less unreasonable. 

From an AF Analyst at Pentagon

Your implicit assumption is that defense spending corresponds to national security. While this is the case to a point, I argue that we can drastically reduce spending without impacting our security. The DoD spends very little energy in resource allocation. 99% of the analysis is rudimentary and accomplished with "parameterized spreadsheet models". The advantage of these "analytical tools" is that decision-makers can rapidly adjust the inputs to create output that supports their preconceived vision. It is telling that our finance and audit personnel have no interest in how O&M and MilPers money is spent... only that every penny is spent by the close of the fiscal year.

P.S. If we allow China to diversify into real assets, it will reduce our "nuclear" option of strategic default on Chinese-held Treasury securities.


It's not that defense

It's not that defense spending cant be reduced and still be effective. To me it's that because of the debt problem we are going to be forced to reduce defense spending regardless and if we get to a point ( future war etc ) it can have a dramatic affect on the country because of the growing debt problem.

I'm not as worried about China buying real estate here as I am of us needing China to buy our debt and hold onto existing debt because if they dont that can be a big problem.
When you owe a country so much money and are dependent on them to keep loaning you money that's the biggest threat to national security because they can start influencing your policy decisions without even needing the threat of force. They can just threaten your entire monetary system and there is nothing you can due about it because you spent like pigs and our politicians brought this all on us themselves ( and us as voters for not holding them accountable )

That's the national security problem right there


Defense budget

I have no doubt that we could cut defense spending a lot without endangering our national security. But that will require a thorough analysis of the defense budget and a serious rethinking of DoD's role in a world in which the nature of conflict has changed radically over the last 20 years. I think the missions of the Air Force and the Navy, in particular, must be seriously reexamined and the sort of one-third allocation for each service that DoD is fond of will have to end.

Furthermore, I fear that if the defense budget needs to be cut quickly, which will be the case if we wait until financial markets force budgetary retrenchment, we are unlikely to make wise decisions about what to cut and where. There is a tendency under such circumstances to cut the things that are easiest to cut and to impose across-the-board cuts rather than make rational decisions about what programs are important and which ones have outlived their usefulness.

 


All the more reason to invest

All the more reason to invest in robust analysis to identify which cuts are prudent. There is a reckoning on the way; government will be Bubble 4.0.


Head of nail, meet hammer

Once again, Bruce you're a pleasure to read. Gates has shown some moxie in cutting a big boondoggle project or two. If he really wants to leave a legacy to his country, the military and the rest of the world, he would find a way to reform the preposterous allocation of funds between the services:
http://www.strategicstudiesinstitute.army.mil/pubs/summary.cfm?q=794
That would provide an opportunity for real thought on how to get the best bang for the buck out of our defense dollars. Given how simple the answers are to the question "when was the last time we fought a naval battle?", I'd imagine (traically optimistically, I suppose) that it might even become politically saleable...


China might not be that eager to get into US real estate

One more thought...
The Chinese may not be that eager to get into American real estate. Just by superficial appearances, the last Asian industrial powerhouse to get into American real estate while also dealing with excess savings and overvalued domestic real estate has done a couple decades of penance for its indiscretions.

Then again real estate can't be that much worse an investment than CDO^2s. If we actually could trace investments back to the Chinese Treasury it would be awfully interesting to tally up how deeply they were into structured finance products.


It is not our current

It is not our current national security profile that is feeding our military-industrial complex, it is the electoral security of our faithful leaders. In fairness, everyone was looking at ways to mitigate an employment disaster in their district and Congress could entice defense contractors to bloat their payrolls in return for building some stuff we dont need.

The other option (I guess Bruce would consider this a tax increase) is to examine more closely the revenue lost to tax expenditures in this country. Before we change any of the marginal rates, let us honestly examine the write off system in this country to see if our "investments" are generating the desired behavior.

Cap Gains=Income
Mort Deduct= gone
Health Ins Deduct=gone
Agri Subsidies= gone

feel free to pile on, there are tons of examples of tax shelters that needless favor one class of citizens over another


Reduce military spending

I can't see the neoconservatives or the tea partiers willing to reduce military spending. Neither are serious about the issues our country faces. The only thing that matter is tax cuts -- and keep my piece of the pie coming (medicare, social security).


Saving is for chumps

Re "It's worth remembering that our government's fiscal profligacy is mirrored by the profligacy of our citizens, who do not save enough to finance domestic investment and appear loathe to reduce their consumption in order to save more."

I'm not sure it's citizens' profligacy as much as it is citizens responding to the incentives set before them, in which the interest rates paid on savings have been at near zero levels for well over a year now. The United States has a political and economic policy-making culture that is quick to turn to the manipulation of economic incentives for policy ends in order to induce socially desirable behaviors. If we as a society value savings, why don't we induce more of it by, say, raising the interest rate paid to savers? The answer is obvious: the society clearly does not value saving beyond the rhetorical level.

Americans are quite rational not to be saving at current interest rate levels, and have figured it out that saving in this country is for chumps.


Saving & Taxes

 Savings rates were much higher in the past when tax rates on saving were much higher than they are now. Conservatives need to grow up and learn that taxes aren't the cause of every problem and that tax cuts aren't the cure.


Let's Vote

What we need is a contest. Let any interested group (not just the 2 political parties) develop a specific plan to balance the budget. Let the CBO score them all and then let Americans vote using some runoff technique like IRV.

This would quickly expose the Republican rhetoric about cutting welfare and foreign aid as being a drop in the bucket, demonstrate that substantive changes have to be made, and let us have a serious debate about our priorities going forward.

As long as a majority of people think you can balance the budget by eliminating the Presidential Election Fund ( http://www.washingtonmonthly.com/archives/individual/2010_05/023766.php )we are not going be have a substantive debate. Make all sides put their cards on the table and see what Americans real priorities are.


Health Care

You really should mention health care in any discussion of debt since it is largest driver of future debt. If you do the math you discover a shocking fact.

We pay over $6000 per capita for health care in the U.S., France and many other nations with single payer plans pay about $3,000 per capita and have a higher ranked health care systems. With over 300 million people in the U.S. that means there is a potential to save over $900 billion a year with little impact.

The real question we need to ask about health care reform is how much longer we can afford to have a free-market system that doesn't work and is bankrupting the country.


Ah yes another trite

Ah yes another trite comparison to a European single payer system and its supposedly superior efficacy. Pointing at their arrangement and concluding it's better is not the same as proving it. Is it possible that Europeans live healthier lifestyles and get sick less often? Is it possible that health care expenditures generate better results when fighting the more limited disease catalogue of a more homogenous population (especially true in the Nordic countries)? Is it possible that their longer vacations, shorter workdays, more pedestrian-friendly cities, higher gas taxes, and laws against adulterated foods might have something to do with their health care costs? Maybe Europeans are spiritually better prepared for their end of days, and not so apt to demand $1 million in treatment to achieve a few more miserable months of life. Incidentally, surveys show that the more religious a person, the less eager they are to depart for the afterlife.

So I'm not convinced that you can just drop a European single payer system into diverse, pill-popping, car and drive-through happy, TV watching America and expect it to save money or extend lives dramatically. My guess is it will bankrupt us even faster. And in any event you've still go to explain why Canadians and Europeans keep flying to the U.S. for specialized procedures.

The better solution is to deregulate health care, get the government mostly out of it, and undertake a massive education campaign to help people make better decisions about their health and insurance matters. And while we're at it yes, we can also close at least half of the military bases we maintain on foreign soil. And charge market rate for our mineral and agricultural leases.


Really?

That is really your argument? Americans are alone among the developed countries in being too fat and lazy for a single-payer health plan? If that is really true don't you think we should try to change that? Maybe the secret to cutting our health care costs is to stop subsidizing corn syrup.

Even if we got half the potential savings it would be over $450 billion a year. This is clearly a better option to balance our budget than the equivalent tax increases or spending cuts, even if it meant we had to wait a few weeks for elective surgery.


It's not an accouting identity

I like much of what you've written above, and particularly your frequent calls for 'adulthood' (for lack of a better term), but what you've called an accounting identity is not.

'Thus insofar as Americans are buying imports they are reducing domestic growth. (This is not an argument for trade restrictions, for reasons I won't go into now, just a simple fact of national income accounting.)'

The key here is that (like a young person borrowing based on expected future income), borrowing (investments) from abroad to consume now does not necessarily reduce future growth - as long as productivity grows (or can be expected to do so). In fact, borrowing from abroad (CAPITAL ACCOUNT inflows are so named for a reason) can accelerate growth. It depends on why the borrowings are taking place.

What is clearly (in my view) aberrant is that China - where productivity IS growing - has such a huge current account surplus. This is just suppression of consumption. The converse is probably also true, and it takes two to tango - the US is effectively encouraging consumption over investment. In China, it's the central bank accumulating the difference and is obvious. Elsewhere, less obvious but nonetheless pernicious for that.

I never learned Stein's Law, but remember well Solow's Lemma - if it can't continue forever, it _probably_ won't.


What about the rest of the (new) spending?

It is convenient to look at the military and see potential savings but where is the discussion on the NEW spending that has come about most recently? The administration was partially elected campaigning against a $498 billion deficit but was able to spend $400+ billion in the Omnibus bill, BEFORE the stimulus($900 billion) package. The fastest way to save $800 billion is to NOT spend the rest of the stimulus money (only 1% or so has been spent so far).


Bainbridge

I read the pre-addendum Bainbridge post and agree with him that
I cannot see how you can characterize his posting as you do.

I saw it more as: I don't trust the liberal democrats (ha!)
to put additional taxes ONLY into defense expenditures.
So until you promise that, I oppose additional taxes.

Bainbridge also fears that liberal democrats that Barlett is now cozy with
(think Blanche Lincoln, Evan Bayh, Mary Landrieu, Ben Nelson, Webb and Tester) would prefer to put money into backstopping union pension funds rather than into defense spending. It is to laugh. Bainbridge probably never heard of Scoop Jackson.


I don't think he was

I don't think he was referring to imports (or imported capital) reducing future growth. By accounting identity he was simply referring to the macro 101 equation for GDP (Y = S + I + C + NX) where Y = GDP, S = Savings, I = Investment, C = Consumption, and NX = Net Exports (and net exports = exports - imports).

Using that equation/accounting identity, there is a dollar for dollar decrease in GDP for every additional dollar spend on imports. A dollar spent on imports reduces GDP rather than contributing to GDP growth as per the equation.




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