Debt Traps, Defense and the Danger of Decline

Traditionally, in American politics, questions of budget deficits and national debt were seen as purely domestic issues that only had ancillary effects on foreign policy.  The situation today is different: debt has become a strategic problem not only because of the magnitude of American debt ($14 trillion), but because our major allies and adversaries are interlocked economically and have their own severe systemic debt and monetary issues. Even China, which enjoys high GDP growth rates, has a crisis of “hidden debt” that reputedly exceeds $1.6 trillion and may, in fact, be several times larger. Among the great powers, when it comes to accumulating risky amounts of debt, no one has clean hands.

Even under the best case scenarios, unless new policies are attempted, the debt situation is going to cause a relative decline of American power and influence in the world. “Best case” assumes that the White House and the Congress will avoid sequestration cuts in 2013, retain enough flexibility in spending in case the economy falls into a recession and the EU manages to avoid collapse over Greek, Italian and Spanish debt. Of the $ 917 billion in budget cuts agreed to in the Budget Control Act, the effects of the cuts fall disproportionately on the Defense department.

The US Navy has plans to reach a 313 ship fleet in 2019, slightly above steady-state after years of decline from a peak of 568 ships. The Air Force is losing at least 200 planes while the Marine Corps and Army face very substantial reduction in active duty personnel, respectively declining from 201,000 to 180,000 for the Marines and a whopping  cut of 100,000 soldiers for the Army, down to 480,000 -490,000. This may not be all as outside advisers to the Pentagon have suggested that the end manpower figure for the US Army may be as low as 390,000. Sometimes smaller is better than bigger, but smaller can’t be in as many places at once as bigger.

However, enthusiasm in Washington for shrinking the numerous missions given to the military to line them up with the Pentagon’s reduced capabilities is nonexistent. This may fool the voters back home, but it doesn’t deceive mullahs in Teheran or North Korean generals that the American ability to respond in a crisis has been circumscribed by capability and costs, particularly when key American allies like Britain and France have made sharp defense reductions of their own. Realistically, we are effective now for one crisis at a time and our ability to juggle any other major problems will be extremely limited, removing some of the “super” from our superpower status that Americans are accustomed to.

The above pales in comparison though to the worst case scenarios, most of which involve a nasty global depression and a meltdown of the international banking system. As this IMF analysis of the major global economies makes clear, debt has become like the interlocking blocks in a game of Jenga. One nation or region making a foolish policy move could jeopardize the entire structure by triggering a cascade of default or depression. The IMF makes some sensible recommendations to step back from the precipice:

  • In the Euro Area, the situation calls for a policy game changer, with urgent steps to banking union (now finally moving ahead), fiscal integration, phased fiscal consolidation and monetary accommodation. Structural reforms must raise growth across—and fix competitiveness problems within—the euro area.
  • In the United States, the priority must be to remove the threat of too sharp fiscal adjustment in 2013, and adopting a credible plan for medium-term adjustment. The recovery can be supported with action on housing and monetary accommodation. Financial reform should be mindful of potential adverse effects on others. 
  • In China, it means preparedness to adapt macro policies to any unexpected weakening in global prospects, and steps to rebalance domestic demand gradually from investment to consumption. 
  • In Japan, the medium-term fiscal adjustment plan now under consideration in the Diet should be doubled to 10 percent of GDP, supported by reforms to raise growth and by monetary easing to escape deflation.
  • In the UK, further steps are needed to fortify the financial system and to underpin confidence in the banks and market institutions that render it a global platform.

In short, the policy prescriptions that politicians know are economically required but avoid because they are politically unpopular, either with voters or with the overly influential banking-finance sector profiting from the excessive debt speculation driving all of our negative trends. If the EU imploded and dragged down the US banking system with it, the number of aircraft carriers we can have in the South China Sea will suddenly be the least of our concerns.

Decline, like debt, is a choice.