Through the development of central banks and active fiscal and monetary policy, the rich world has managed to avoid serious depression for seven decades. Yet big finance—which tends to grow ever larger when crises are rare and credit risks seem muted—hides deep political flaws, the costs of which compound over time. Relative to the size of the world economy, global debt markets overall are two to three times their size in 1970.
Bankers and politicians seem to enable the worst characteristics and behaviors of the other. The past few years have led us to focus on half of that phenomenon: the degree to which government guarantees have facilitated irresponsible risk-taking on Wall Street. And this is, of course, an issue that demands continued attention.
But Japan illustrates the other half of the phenomenon—the extent to which finance has allowed and encouraged politicians to make attractive short-term decisions that are eventually damaging. This may ultimately yield worse crises than the one we faced in 2008 or the one now unfolding in Europe. Greece, Ireland, Portugal, Spain, and Italy found their own ways to economic devastation, but each road was paved with easy credit. Those whom the gods would destroy, they first encourage to borrow cheaply.
Of course, the U.S. is not immune. The immediate problem is not Social Security: that program’s promises can still be covered by modest taxes, and significant immigration has helped prevent a demographic decline like the one Japan is seeing. Nonetheless, the U.S. needs to issue government debt worth about 25.8 percent of GDP this year, to roll over its debts and finance the deficit. About half of the federal government’s debt is already held by foreigners. And a tax revolt has been building since the mid-’70s. Today, one side of the political spectrum refuses to consider rebuilding revenue to the pre–George W. Bush levels—and proposes to cut taxes further. The other side resolutely defends spending programs and middle-class tax breaks. Health-care spending, meanwhile, keeps rising—largely because powerful lobbies can veto meaningful cost control.
Perversely, interest rates on U.S. government debt are lower than at any other time in living memory—the result, largely, of economic dangers elsewhere. The Europeans have ruined their economies—and we have benefited from the consequent inflow of capital to our government debt, which has pushed rates down. When Japanese investors begin abandoning their home country, we will benefit again.
These benefits are temporary. Yet politicians have a hard time paying serious attention to fiscal deficits while foreign capital floods in. Even once the U.S. economy recovers, will the government really get its debt under control?
The financial sector is a powerful lobby. What policies does it demand? Financiers want pro-bailout policies kept in place—particularly the massive implicit guarantees against failure that they receive. And they want continued deficits. Our financial titans pay lip service to fiscal responsibility, but they primarily want to pay fewer taxes—irrespective of what this means for government debt. Indeed, bigger deficits create larger markets for government debt and all of its derivative products, which in turn allow the financial sector’s profits to grow larger. Many politicians are only too happy to oblige.