Causes for the Deepening United States Economic Crisis

| by Shehani A. Wimalawansa and Sunil J. Wimalawansa

( June 13, 2013, New York City, Sri Lanka Guardian) The United States budget deficit has been escalating over the past few years, affecting both individuals and businesses. In January 2012, the patchwork legislation by Congress led to the postponement of the Fiscal Cliff, but the sequestration materialized. The November 2012 elections did not make significant changes in the US leadership, and no tangible, sustainable, long-term economic plans or solutions for the country have emerged. Nevertheless, the deficit must be dealt with firmly, whether through austerity measures or stimulating growth.

Key causes that lead to increasing debt ratio:

Slowing the economy has led to massive layoffs and escalating unemployment. Inefficiency, waste, and the costs of unemployment further increase the governmental debt. The US government spends more money on “entitlements” (Medicare, Medicaid, pensions, interest) than it collects from total tax revenues each year. Therefore, unless a rapid growth is achieved with massive job creation programs, break-through innovations, or radical organizational modifications, the government debt will continue to accumulate at a rate of more than one trillion dollars a year. 

Currently, approximately 24 million American adults are unemployed or underemployed. Thus, each year in the United States, approximately 40 billion man-hours are wasted that could have contributed to the economy. When unemployment is high, government tax collections decrease and payments for entitlements, including unemployment benefits, increase. Consequently, larger cities, including New York City, experience an increase in homelessness despite the increasing net worth of these cities.

Root causes of the current financial crisis:

In 2012, the US government spent 3.8 trillion dollars but collected only 2.46 trillion dollars, thus leaving a budget deficit of 1.3 trillion for the year. By the end of 2012, the government’s cumulative debt was 16.4 trillion dollars, which is 25% of the world’s total GNP. This governmental debt is estimated to increase to 25.9 trillion dollars by 2021. The government’s spending falls into three broad categories: (A) security (military, Federal Bauru of Intelligence, Central Intelligence Agency, etc.) and non–security-related (education, energy, and so forth), 1.3 trillion dollars per year; (B) mandatory programs, 2.37 trillion dollars per year; and (C) net interest payments, 0.26 trillion dollars per year. To have a significant impact in reducing debt, the government needs to adapt spending cuts, which need to encompass all mandatory payments. This is what the private sector would do when they face financial difficulties; they would tighten their budgets by minimizing waste and becoming more efficient. There is no reason why the government should not do the same.

In 2012, the mandatory payments that include Social Security, Medicare, Medicaid, unemployment benefits, and others, amount to 2.4 trillion dollars per year, which is similar to the total tax revenues collected. Thus, even if stringent austerity measures are enforced, it would take many years to bring down the debt, and citizens would have to live through a dark and miserable period. On the other hand, wise spending that targets large-scale job creation and facilitating an innovation-driven economy would lead to a promising rapid recovery without such suffering. Such spending however needs to go hand-in-hand with sustainable jobs, creating several million new jobs a quarter, which is necessary to reestablish financial solvency.

Rising debt, economic burden, and unemployment:

The Federal Reserve is funding the US national debt―over $16 trillion―by increasing the money supply and lending to banks. For the past four years, the US Federal Reserve monetized the US debt approximately, one trillion dollars annually. Meanwhile, the real interest rates are practically negative, thus depriving millions who save in banks, especially squeezing the retirees who rely on their interest income.

Successive US governments over the past decade have (A) delayed and deferred making decisions in addressing the fiscal deficits, (B) continued to borrow more than three billion dollars a day—more than one trillion dollars a year―to finance the federal budget deficit, (C) monetized and increased spending without sustainable job creations, and (D) allowed crises to occur, leading to chaos and uncertainty. This synthetic economic framework cannot continue forever without negative consequences. Thus, the application of immediate and serious fiscal responsibility is warranted.

In addition, successive governmental policies have opened doors to escalating healthcare costs―one of the major burdens on the economy―and soaring health insurance and technology costs, while the tangible quality of services and access to care are decreasing. Despite significant technological and extraordinary medical advances in the United States, which has the highest per capita costs for medical care, the nation is not identified among the world’s top ten countries for best health care services. This trend must be changed.

Why is the current financial crisis continuing?

Why are we not making a significant progress in solving the current financial crisis? Whether this is because of the failures of fiscal and other policy issues or because we do not have the right policies, willpower, or political dogma is unknown. What prevents bipartisan efforts to curtail government expenses, while encouraging businesses to invest and expand the job market? Appropriate and timely changes of philosophy are critical to a rapid recovery through growth, new inventions, entrepreneurships, and enhanced tax revenues by increasing employment and business ventures.

The government sector contributes to only approximately one fifth of the jobs in the economy. However, it is responsible for the maintenance and improvements in the basic infrastructure of the country using tax revenues. It is estimated that more than five-hundred billion dollars could be wisely spent per year, during the next five years to improve the ailing infrastructure, create new jobs, and kick-start the economy. Moreover, incentivising the private sector will generate the most number of jobs in the economy that would contribute to sustainable and robust economic growth.

When government deficits are financed through borrowingdebt-monetizationas we have been doing for the past few years, the outcome is likely to be an increase in the money supply leading to devaluation of the U.S. dollar. Moreover, the increasing money supply would shift the aggregate-demand curve to the right, increasing prices and rising inflation. It will also put pressure on U.S. dollars, so that worldwide, in the long run, one of the other international currencies may take over as the investment of choice by other countries. That would have a major negative consequence for the future U.S economy. Continued monetization [quantitative easing (QE)] to cover the rising debt is a “death trap,” as was vividly seen in Greece in 2011. When debt obligations exceed annual GDP or income, a company, country, or government can fail.

(Potential solutions to this crisis will be discussed in the next article in the Guardian;
“United States Current Economic Crisis: Solutions”)

[Sunil J. Wimalawansa, MD, PhD, D.Sc., MBA;;
Shehani A. Wimalawansa, Rutgers Business School, New Brunswick, NJ, U.S.A.]