You Better Pay Attention To Bill Gross

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The national debt and Washington's deficit of will

By Joel Achenbach
Sunday, April 25, 2010; B01

Bill Gross is used to buying bonds in multibillion-dollar batches. But when it comes to U.S. Treasury bills, he's getting nervous. Gross, a founder of the investment giant Pimco, is so concerned about America's national debt that he has started unloading some of his holdings of U.S. government bonds in favor of bonds from such countries as Germany, Canada and France.

Gross is a bottom-line kind of guy; he doesn't seem to care if the debt is the fault of Republicans or Democrats, the Bush tax cuts or the Obama stimulus. He's simply worried that Washington's habit of spending today the money it hopes to collect tomorrow is getting worse and worse. It even has elements of a Ponzi scheme, Gross told me.

"In order to pay the interest and the bill when it comes due, we'll simply have to issue more IOUs. That, to me, is Ponzi-like," Gross said. "It's a game that can never be finished."

The national debt -- which totaled $8,370,635,856,604.98 as of a few days ago, not even counting the trillions owed by the government to Social Security and other pilfered trust funds -- is rapidly becoming a dominant political issue in Washington and across the country, and not just among the "tea party" crowd. President Obama is feeling the pressure, and on Tuesday he will open the first session of a high-level bipartisan commission that will look for ways to reduce deficits and put the country on a sustainable fiscal path.

It's a tough task. The short term looks awful, and the long term looks hideous. Under any likely scenario, the federal debt will continue to balloon in the years to come. The Congressional Budget Office expects it to reach $20 trillion over the next decade -- and that assumes no new recessions, no new wars and no new financial crises. In the doomsday scenario, foreign investors get spooked and demand higher interest rates to continue bankrolling American profligacy. As rates shoot up, the United States has to borrow more and more simply to pay the interest on its debt, and soon the economy is in a downward spiral.

Of course, at least in theory, this problem can be fixed. Unlike a real Ponzi scheme, which collapses when no new suckers offer money that can be used to pay off earlier investors, the government can restore fiscal sanity whenever our leaders decide to do so.

But that premise is what has people like Gross worried. In addition to running a budget deficit, Washington for years has had a massive deficit of political will.

Over the past decade, lawmakers have avoided the kind of unpopular decisions -- tax increases, spending cuts or some combination -- needed to keep the debt under control. Federal Reserve Chairman Ben Bernanke testified recently that, for investors, the underlying problem with the debt isn't economic. "At some point, the markets will make a judgment about, really, not our economic capacity but our political ability, our political will, to achieve longer-term sustainability," he said.

The economic recovery has been picking up steam in recent weeks -- "America's Back!" trumpets Newsweek -- but the political recovery has been feeble. Whether on taxes, entitlements, military retooling, financial reform, energy policy or climate change, Washington is mired in a political enmity that makes tough decisions nearly impossible.

In the fiscal debate, the default position, as it were, is to do nothing. Debt is the grease of Washington legislation; for short-sighted leaders, it is less a political problem than a political solution. As long as the government can continue borrowing at reasonable rates, citizens can have their tax cuts and government services, and eventually the growing debt becomes someone else's problem.

"This is all an exercise in current generations shifting burdens on future generations," Brookings Institution economist William Gale says. "Future generations don't vote, of course."

Many careers in Washington have come to an end as casualties of the long battle to restore fiscal balance. President George H.W. Bush in 1990 went back on his "no new taxes" pledge and lost much of his political base. By the narrowest of margins -- with Vice President Al Gore breaking a tied vote in the Senate -- President Bill Clinton raised taxes again in 1993, and House Democrats were pummeled in the following year's midterm elections, giving up control of the chamber to the GOP for the first time in 40 years.

But then, after two decades of deficits, the fiscal picture brightened unexpectedly. The peace dividend at the end of the Cold War combined with the booming economy of the 1990s (and some tech-bubble tax receipts) to create an unexpected dilemma in 2000: what to do with the budget surpluses that were forecast for years to come? One obvious idea was to pay down the existing publicly held debt, then hovering around $3.4 trillion.

But a decade later, we're back in debt madness. The causes of this reversal are not a mystery: tax cuts, two wars, a new Medicare drug benefit, two recessions, massive bailouts and a huge stimulus package -- very little of it paid for in any conventional sense. Obama never misses a chance to remind the public that he inherited an enormous deficit, but as a purely political matter he still needs to persuade the public that he's a prudent fiscal steward.

To that end, the president has proposed a freeze on most nonmilitary discretionary spending. Obama also insisted that the health-care overhaul not add to the deficit, and it won't, according to the CBO. But no one would confuse the health-care law with a deficit-reduction package. Critics say the law worsens the fiscal outlook because its spending cuts and new taxes could have been used to reduce the deficit -- which may run at about $1.3 trillion for 2010 -- instead of being an offset for an entitlement expansion.

Beyond the simplicity of the problem -- the Treasury spends more than it collects -- is a thorny mess of policy options. Conservatives fear that liberals want to expand government by imposing a European-style value-added tax, in which the government sips revenue at multiple stages in the production and sale of goods and services. But a VAT is regressive, would hit the middle class in the teeth and is probably too politically radical to survive beyond the haven of a few Washington think tanks.

Obama's vow not to raise taxes on the middle class -- meaning he's extending George W. Bush's tax cuts for everyone except the most affluent -- eliminates a lot of revenue options. "The Republican view is no new taxes, and the Democratic view is no new taxes on 95 percent of the population. Both of those are so far from reasonable starting points that it's astonishing," Gale argues.

Obama and his fellow Democrats may also be shy of substantial Pentagon cuts, lest they be pegged as weak-kneed liberals. Some of the easiest Medicare cuts have already been made. That leaves Social Security, and such options as postponing the retirement age or means-testing benefits. But recipients figure they paid into Social Security and it's their money, not to be taken away. And they vote -- and live by the millions in swing states such as Florida.

With so many unpleasant options, everyone is looking to Obama's new bipartisan commission for some kind of miracle solution. The 18-member panel, headed by former Clinton White House chief of staff Erskine Bowles and retired Republican senator Alan Simpson, is charged with producing recommendations by Dec. 1, after the midterm elections. Congressional leaders say they'll vote on the recommendations, but the commission has no real clout. A panel proposed by Senate colleagues Kent Conrad (N.D.), a Democrat, and Judd Gregg (N.H.), a Republican, would have had more teeth, but the idea died in the ideological crossfire early this year.

Even before the commission's first meeting, the body is already in the thick of the political battle, with antitax advocate Grover Norquist suggesting that Simpson has a history as a tax hiker. The retired senator struck back in a statement: "This 'Mr. Tax Hike' business is garbage, and is intended to terrify people and at the same time make money for the groups who babble it."

In an interview, Simpson said the capital has an aversion to dealing with debt. "It makes all sorts of sense if you're worshiping the great god hiding behind the screen, which is called reelection," he told me.

The latest news from the Treasury is hopeful: Tax revenues are slightly higher than anticipated so far this year. The TARP program to bail out financial firms has proved far less costly than expected. Investors from around the world still eagerly bid on Treasury notes at auction. During this global recession, the U.S. Treasury has been a safe port in the storm.

When I spoke to Peter Orszag, the director of the Office of Management and Budget, he expressed optimism that the administration can balance the primary budget -- not including interest payments -- by 2015. The longer-term deficits are his bigger worry. Asked if the political process in Washington is broken, he answered: "I think it's too soon to know whether the system's broken. The problem is not what happened last year or this year. The real issue is when we move forward in time, something has to give."

The danger is that what "gives" will be investors' confidence in the United States. Bill Gross told me that Pimco still has $150 billion in Treasuries, but that's seriously "underweight" given that the company controls $1 trillion in assets.

"It's becoming immediately apparent that some countries will not do especially well and may not escape the debt trap from the recent financial crisis, Greece and Iceland being the most prominent cases," Gross said. "But now investors are even looking at the best of the best, including the United States."

That's also the concern of Michael Burry, the investment guru who predicted Wall Street's meltdown and made millions by placing bets against (or "shorting") the financial sector. Burry, one of the protagonists in Michael Lewis's account of the financial crisis, "The Big Short," believes the federal government is behaving like the companies that lost billions in mortgage-backed securities. He told me he sees the common mistake of focusing on short-term benefits -- whether quarterly earnings or the next election.

The world doesn't want America to go broke, he points out. Americans are the planet's greatest consumers. But if this is a bubble, it will burst with little warning, Burry said.

"Strictly looking at the monthly Treasury statement of receipts and outlays," Burry said, "as an 'investor,' you see a company you might want to short."

Joel Achenbach is a reporter and blogger on the national staff of The Washington Post. He will be online on Monday, April 26, to chat with readers at 11 a.m. Submit your questions or comments before or during the discussion.