The United States is addicted to oil, President Bush warned Americans last week in his State of the Union address.
But what's likely to hurt us more in the long run — our addiction to oil or our addiction to debt?
The oil addiction we share with the rest of the planet. Debt addiction isn't our issue alone among major nations, but as the world's biggest economy our fearless embrace of debt in recent years has created risks that are global in scope.
We can cut back on oil consumption. Even if we stop borrowing tomorrow, however, our outstanding debt still must be repaid or refinanced.
And those bills will come due in the next 20 years concurrent with 79 million baby boomers reaching retirement age. In theory, at least, they're going to take more from the economy than they contribute, stretching already leveraged resources.
The problem with any discussion of U.S. debt levels is that the nation has largely become inured to the topic. Warnings about excessive debt have been a staple on Wall Street since the early 1980s. Yet stock and real estate prices have soared and interest rates have plunged since then.
What's more, whether our debts really have become excessive depends on what you measure them against. By some standards they don't look so onerous, particularly if you assume the economy keeps rolling along.
What we do know for certain is that the U.S. has been on a borrowing binge in this decade. The federal debt, for example, now is $8.2 trillion, up from $5.5 trillion just seven years go.
This week, the Treasury will issue 30-year bonds for the first time in more than four years. Uncle Sam will sell $14 billion of the securities Thursday. The return to the market of the 30-year bond is another sign of how dramatically the nation's debt picture has changed since 2000, when the government actually was running a budget surplus for the first time since the 1960s, and was paying down debt.
U.S. household debt, including mortgages, jumped from $6.4 trillion at year-end 1999 to $11 trillion by the end of the third quarter last year, a 72% increase, according to Federal Reserve statistics. The growth rate in household borrowing has reached double digits in recent years, a pace not seen since the mid-1980s.
The pace of borrowing by state and local governments also has accelerated sharply since 2000; lately it has picked up in the corporate sector as well.
Borrowers have been encouraged in this decade by the Federal Reserve, which from 2002 through mid-2004 kept interest rates at rock-bottom levels to bolster the economy.
And part and parcel with the rise in debt levels has been the surge in the U.S. current account deficit, the broadest measure of the nation's balance of trade and investment with the rest of the world. That deficit was about $200 billion in each quarter last year, double the pace of 2000 and nearly four times that of 1998.
A current account deficit tells you that a country is consuming more than it produces. One way to sustain that trend is to borrow to fund your consumption.
Americans have heard plenty in recent years about the ravenous appetite foreign governments have had for our Treasury securities. Foreign holdings of Treasury debt zoomed from $1.02 trillion in December 2000 to $2.17 trillion as of November.
But it isn't just Treasury debt foreigners have bought. The U.S. housing boom has been funded in part by foreign investors via their purchases of bonds backed by home mortgages.
This circular relationship has served all parties well so far. You know the story: Governments like China's effectively lend us the money to consume the goods they produce. By buying our debt, they help keep long-term interest rates down (and also finance the war in Iraq). We help keep their workers employed and enjoy the fruits of their labor.
Larry Fink, chief executive of BlackRock Inc., which manages more than $400 billion in assets for investors worldwide, says his Asian clients tell him they're very happy with this relationship.
"They would like this circle to last forever," Fink says. "And that's what frightens me. The whole world likes this model. It feels too good."
The danger, of course, is that we will borrow more than is healthy — meaning more than we can afford in the long run. And the more we're on the hook to foreign creditors, the less we control our own economic destiny.
One school of thought says the borrowing binge really isn't a problem, at least not yet. The optimistic view of the current account deficit is that it's a sign foreigners have great faith in the U.S. economy, because they're so willing to hold our investment paper and our currency.
Another counter argument to debt concerns is that the large numbers are misleading in isolation. The fiscal 2005 federal budget deficit was $319 billion, but as a percentage of U.S. gross domestic product it was 2.6% — much lower than in the mid-'80s, when deficits exceeded 4.5% of GDP four years in a row.
Similarly, although consumer debt overall has soared, it should be compared with the other side of the balance sheet: the value of Americans' assets.
By the Fed's reckoning, even though debt levels have mushroomed, American households' net worth — assets minus debt and other liabilities — was $51 trillion as of Sept. 30, up from $42.4 trillion at the end of 1999.
But household net worth has grown at a far slower pace than debt in this decade. And the problem with assets, including real estate, is that they can decline in value, while the owner remains fully liable for the debt used to buy them.
For now, there is no sign that the circle as described by Fink is coming undone. And it may not soon. If we can survive a current account deficit of $200 billion a quarter, why not $300 billion?
The nightmare scenario is that the U.S. economy begins to struggle under its debt load, causing foreigners to quickly lose their appetite for our securities, in turn sending the dollar's value tumbling, U.S. interest rates shooting higher and stock prices collapsing.
Warnings about the peril of high debt, and particularly about reliance on foreign creditors, were heard in the early '80s as well. Obviously, the Republic still is standing, the economy far larger, and investors far richer for staying in stocks and bonds.
The one crucial difference today compared with the 1980s is that the U.S. then wasn't confronting the imminent retirement of the baby boomers, with all of the attendant costs for Social Security and Medicare.
If prudence were in a little greater supply, U.S. consumers would begin to slow their borrowing and spending, and focus on rebuilding their balance sheets by saving more. The Federal Reserve could encourage this shift by continuing to tighten credit, painful as that may be.
As for Uncle Sam, nearly everyone agrees that the budget deficit should be brought down, and quickly, with the boomer retirement wave looming. But talk is cheap.
The great risk with economic and financial imbalances like excessive debt is that it often takes a crisis to correct them. The stakes seem far too high to be resigned to that kind of resolution.
