That Used to Be Us: How America Fell Behind in the World It Invented and How We Can

by Thomas L. Friedman

  In the first decade of the twenty-first century, the attacks on New York and Washington of September 11, Islamic terrorism, Osama bin Laden, Afghanistan, Iraq, and homeland security preoccupied Americans. We believe, however, that if we don’t change course, twenty-five years from now the war we undertook with al-Qaeda won’t seem nearly as important as the wars we waged against physics and math. We will be paying for these two wars far longer. And that’s the optimistic scenario.

  If we don’t shrink the deficit to a more manageable size while investing in our traditional formula for success, and if we don’t address our long-term clean-energy needs while mitigating climate change, we will effectively be outsourcing America’s fate to the two most merciless, unemotional, and unrelenting forces on the planet: the market and Mother Nature. These two will determine, each in its own time and its own way, when its limits have been breached, when the laws of nature and of economics will kick in, when the music will stop, and when the adjustment to our lifestyle—which will be nasty, brutish, and long—will start.

  The next two chapters explain how we got to this point.

  NINE

  The War on Math (and the Future)

  Arithmetic is not an opinion.

  —Italian proverb

  In the winter of 2011 The New Yorker ran a cartoon showing an elderly man meeting with his banker. The caption underneath had the man saying, “I want to take out one of those mortgages on my grandchildren’s future.”

  That little cartoon summed up not only how we have behaved in the past but how much damage we can still do to our future if we don’t change course and bring our national debt, entitlements, and annual deficits under control—in an intelligent way. Given all of our excessive spending since the end of the Cold War, a certain amount of intergenerational conflict over who pays what is now impossible to avoid, as the cartoon suggested. What remains to be determined is whether it is a battle or a full-fledged civil war—the old against the young. The battle lines have already been drawn: Medicare versus Pell Grants for college tuition, nursing homes versus community colleges, the last year of grandma’s life in the hospital—which takes up roughly 30 percent of Medicare.—versus the first eighteen years of your child’s life in public school.

  Even though these battles are being fought today by accountants with calculators, their outcome will be no less important in shaping our nation’s course in the decades to come than the battles of Gettysburg and Bull Run were for the nineteenth century. Many Americans now wrongly believe that the issue we face is whether or not we will reduce the annual federal budget and which programs will get dropped or trimmed. Rest assured, the budget will be cut and programs will be trimmed. The markets will eventually make sure of it. We have no choice.

  The important question is: On the basis of what priorities and what vision will those cuts be made? Will we reorganize government spending in a way that invests in the future, or in a way that just pours more money into the past? It is a hard choice. Deserving programs and deserving people will be cut because we simply cannot keep all the promises we have made to ourselves. We have made too many, which are too big, for too long. So if we don’t take the initiative—if we don’t cut spending, increase revenues, and invest in the future all at the same time, based on an accurate reading of the world in which we are living and what we will need to thrive in it—we will pay a huge price. It may be possible to grow effectively without a plan, but there is no way to shrink effectively without a plan.

  The fix America is in reminds us of a scene in Orson Welles’s 1958 film Touch of Evil, about murder, kidnapping, conspiracy, and corruption in a town on the Mexican-American border. Welles plays a crooked cop who tries to frame his Mexican counterpart for a murder. At one point, Welles stumbles into a brothel and finds the proprietor, Marlene Dietrich, who is also a fortune-teller, with cards spread out in front of her.

  “Read my future for me,” Welles says.

  “You haven’t got any,” she replies. “Your future is all used up.”

  If we don’t reshape our budgets properly, reducing our soaring deficits but also reinvesting in our formula for greatness, that will be us: a country with its future all used up.

  The rest of this chapter is about how we got into this situation and how we get out of it—with a future.

  Paint by Numbers

  Beginning in the late 1960s, the United States got out of the habit of paying for what the federal government spends with money the government collected through taxes. Year after year, the government ran a deficit. As the annual deficits accumulated, the total national debt grew, although its proportion of the growing American economy did not increase rapidly. It stood at $5.6 trillion in 2001, but over the next nine years it increased dramatically. By 2011, it had reached $14 trillion—the equivalent of the country’s GDP—with the prospect of increasing to $16 trillion by 2012 without countervailing steps.

  “Total American general government debt today is at a phenomenal level,” said Kenneth Rogoff, a professor of economics and public policy at Harvard University and formerly the chief economist at the International Monetary Fund. Rogoff is also the co-author with Carmen Reinhart of This Time Is Different: Eight Centuries of Financial Folly, which surveys the history of debt and financial crises. “By our benchmark,” Rogoff added, “when you take local, state, and federal government debt together we are at our all-time high—above 119 percent of GDP. That is even higher than at the end of World War II, which is the only time before now that we have ever been that high … We are at the outer edge of the envelope of the last two hundred years of experience. We look at sixty-six countries in our book, going back over two hundred years, and find that debt levels over 120 percent of GDP are quite exceptional.

  And soon it will get worse. The retirement of seventy-eight million baby boomers—Americans born between 1946 and 1964—will cause the costs of the two main entitlement programs, Social Security and Medicare, to skyrocket. Between 2010 and 2020 they are scheduled to rise by 70 and 79 percent, respectively. By 2050, paying for both, plus Medicaid, could take a full 18 percent of everything the United States produces in a year. The actual size of the gap between what the country is pledged to pay out to the boomers over the decades of their retirement and the amount of money the government can expect to collect at current tax rates is a matter of debate, but there is no doubt that that gap, if left untended, is very, very large. Estimates of the gap run as high as a staggering $50 trillion to $75 trillion. (Again, the total GDP of the United States in 2010 was about $14 trillion.)

  That’s a lot of money to borrow. To be sure, borrowing money, for an individual, a firm, or a country, is not always a mistake. Indeed, it is justified, even necessary, when the money borrowed is needed to cope with an emergency, such as the economic crisis of 2008. “In the midst of the global financial crisis,” remarked Mohamed El-Erian, the co-CIO of PIMCO, a global investment management firm and one of the world’s largest bond investors, “policymakers took the right decision in using public balance sheets to offset the massive disorderly de-leveraging of private balance sheets—those of banks, companies, and households. To use the phrase of my good friend Paul McCulley, the responsible thing was to be irresponsible.” Borrowing money also makes sense to enhance a nation’s long-term productive capacity because the debt can easily be paid back out of a growing income. A person is well advised to borrow to get an education, a firm to modernize its plant, a country to import cutting-edge technology.

  The United States, however, has been borrowing not for investments of this kind and not only to cope with the economic crisis and fight wars but also for consumption. Borrowing money has made it possible for Americans to buy toys, cars, iPods, and vacations, which do nothing to make us better able in the future to pay off the debt the country is piling up. On the contrary, an out-of-control national debt poses serious threats to America’s future. In the short term, the country’s creditors may lose confidence in its ability, or at least its
political will, to repay its debts, and that can lead to a vicious cycle, or feedback loop: a devalued currency spurs inflation, inflation leads to higher interest rates, and then come more devaluations, even higher inflation, and higher interest rates.

  We like the way Robert Bennett, the former businessman who served three terms as a Republican senator from Utah before losing the Republican nomination to a Tea Party candidate in 2010, explains it. “If you are asking the wrong questions, the answers don’t matter, and increasingly we are asking the wrong questions. There is really only one fundamental question: What is the borrowing power of the United States of America? When I took over the Franklin International Institute, to run it as a business, it had a debt of $75,000. When I stepped down as the CEO, it had a debt of $7.5 million. Well gee, I was a complete failure—except that they could not pay the debt of $75,000, and if the bank had called it, the company would have been shut down. And, when we had a debt of $7.5 million, we had over $8 million in cash in the bank; we had sales approaching $100 million and our pretax margin on those sales was 20 percent. So we were earning close to $20 million a year, and the only reason we didn’t pay off the debt is that it had some prepayment penalties. So we clearly had substantially more borrowing power than $7.5 million. So it’s the question of: What is the borrowing power of the United States? … Nobody can project it because the economy is constantly growing, constantly changing. But there is a feeling certainly in my gut and those of the economists whom I trust that we are approaching that limit. Now, once you go over that limit, wherever it is, you are Greece; you are Ireland; you are Zimbabwe. That’s the great issue: How do we make sure that the U.S. government does not approach that unknown number?”

  That is indeed the great issue right now, and there is a growing consensus that we are approaching that unknown number. As we do, we should heed Rogoff’s advice: “When it comes to the question of how high is too high, nobody really knows. But complex arguments should not defeat common sense that you are taking a risk heading way further down this down road.” Or as El-Erian put it: “It is no longer responsible to be irresponsible.”

  Common sense also says that the right strategy now is neither to slash all discretionary government spending suddenly nor to continue piling up debt to keep the economy stimulated, as if there are no implications for that down the road. The right strategy is to have a strategy—a strategy for long-term American growth and nation-building at home. That will require us to cut spending, to raise taxes, and to invest in the sources of our strength, all in a coordinated way.

  But before we discuss that, let’s step back for a moment and ask: How in the world did we get into this position?

  Present at the Creation

  From the end of World War II until Ronald Reagan’s presidency, American budget history was pretty boring. The federal government ran manageable annual budget deficits and the economy steadily grew, so our debt-to-GDP ratio fell. Since the big change occurred during the Reagan presidency, we decided to ask someone who was present at the creation: David Stockman, the budget director during Reagan’s first term and a sharp critic of recent American fiscal policy. Stockman argues that the ground was prepared for the budget-busting that started in the 1980s by an event that occurred four full decades ago.

  On August 15, 1971, the U.S. government put an end to the international monetary system that the United States and Great Britain had devised at Bretton Woods, New Hampshire, in 1944. Under that system, the dollar was tied to the price of gold and international exchange rates were fixed, which imposed fiscal discipline on all participating countries, including the United States. The government couldn’t print and spend money as much as its leaders wanted. “When we collapsed Bretton Woods,” argues Stockman, “we took discipline out of the global economy. When the dollar was tied to fixed exchange rates, politicians were willing to administer the needed castor oil because the alternative was to make up for any trade shortfall by paying out our reserves, and this would cause immediate economic pain in the form of higher interest rates.”

  President Richard Nixon scrapped the Bretton Woods system in order to avoid putting the country through a recession to pay for all of the excess government spending going to fund the Vietnam War. As Stockman put it: Nixon, listening to famed University of Chicago economist Milton Friedman, said, Let’s just let our currency and everyone else’s float and the free market will find the right exchange rates among us all. If we run persistent deficits, our currency will lose value against those of countries that don’t and that will quickly wipe out any trade deficits; the hidden hand of the market will ensure that currencies automatically adjust up or down, depending on how we each manage our economic fundamentals. The reality turned out to be more complicated, but it took a while to unfold.

  Deficits ballooned during Reagan’s first term, when tax cuts, skewed toward the wealthy, reduced the revenue base by a full 5 percent of GDP while the government continued domestic spending virtually unchecked. (It fell by barely 1 percent of GDP and was overwhelmed by the costs of the Reagan defense buildup.) This alarmed Reagan, who was part of the Greatest Generation and who was not at all a fan of deficits. So he enacted five different tax increases over the remainder of his time in office, which, according to Stockman, took back more than 40 percent of the original reductions. Reagan also led a reform of Social Security in 1983 to shore up the system.

  Recall the words of former vice president Cheney, whom we quoted earlier: “Reagan proved deficits don’t matter.” Reagan not only did not prove that deficits don’t matter; he did not believe that deficits don’t matter. This is a fiction that would be manufactured later by a new generation of conservatives either out of ignorance or for their own selfish or ideological reasons.

  “Ronald Reagan never called them taxes,” recalled former senator Bennett, the Utah Republican. “They were ‘revenue enhancements.’ [Senator] Pete Domenici described it to me once: he said, ‘We went down to the White House and said, “Mr. President, we can’t survive on this level of revenue.” And, Reagan said, “Okay, maybe we ought to have some ‘revenue enhancements.’”’ And so the gas tax went up, which it should have, and should be going up now.”

  Neither of the presidents who followed Reagan wanted to raise taxes, but to their credit, both decided to do so rather than go to war on math. President George H. W. Bush put his presidency in jeopardy to keep the deficit under control by breaking his famous promise: “Read my lips—no new taxes.” Then our first baby boomer president, the Democrat Bill Clinton, made deficit reduction one of his top priorities as well—due, in part, to the strong showing in the 1992 presidential election of H. Ross Perot’s third-party candidacy, which was dedicated to slashing the deficit above all else. In 1993 congressional Democrats enacted a deficit-reduction bill without a single Republican vote; Vice President Gore broke a tie on August 6, 1993, to pass the measure in the Senate. Four days later Clinton signed the Budget Reconciliation Act, which included about $240 billion in tax increases for high-income earners and $255 billion in spending cuts.

  This is when Reagan’s bad imitators began to make themselves felt in the Republican Party. In the wake of Clinton’s 1993 budget, Representative Dick Armey, a Texas Republican, predicted that “the impact on job creation is going to be devastating.” “The tax increase will lead to a recession and will actually increase the deficit,” argued Newt Gingrich, a Republican congressman from Georgia. (In 1995 Armey and Gingrich became majority leader and Speaker, respectively, of the House of Representatives.) No such things happened. Instead, reinforced by the dot-com boom and the peace dividend, the Clinton deficit-reduction measures turned what was then the largest deficit in American history into a budget surplus and laid the foundation for several years of solid economic growth. America was projected to be “debt free” by … 2012.

  Since the 1970s, actuaries had been issuing reports saying that, given the aging of the baby boomers, a fiscal crunch would occur in America sometime between 201
0 and the 2020s. The Clinton administration’s economic policies were designed in part to generate budget surpluses that could pay down the deficit before the baby boomers retired and began to draw on Social Security and Medicare. As a result, from 1993 to 2001 America’s debt-to-GDP ratio went from 49 percent to 33 percent. Simply put, we cut our debt from half our annual output to a third. That used to be us.

  Young Republicans

  Then came the administration of George W. Bush. Alan Blinder, a Princeton economist and former vice chairman of the Federal Reserve, summed up what happened in a brief essay in The Wall Street Journal (December 17, 2010):

  The nation took leave of its fiscal senses, and simply stopped paying for anything during President Bush 43’s eight years. Not for huge tax cuts—once again skewed toward the rich. Not for the Medicare drug benefit—which, in fairness, is skewed toward the poor. Not for two wars. That spree was followed by the financial crisis, the Great Recession, and the policy responses thereto—all of which blew up the deficit massively under President Obama.