Current Bubble of the Imperial Economy

What follows is a long but compelling explanation of why Imperial Nation is headed for an economic freefall, by Clive Crook:

" Once upon a time Democrats were big spenders and Republicans were fiscal conservatives. That was a while ago. Ronald Reagan's defense buildup and tax cuts caused deficits to soar in the 1980s, and it was Bill Clinton who brought the budget back into surplus in the 1990s, partly by curbing spending. But those fiscal role reversals were timid by today's standards. Since 2000 the Democratic Party has been left in the dust when it comes to spending.
The Republican Party is the new, undisputed champion of big government. The Bush administration has presided over an explosion of public borrowing, fueled partly by tax cuts but also by huge new outlays. Both sides of the public accounts were out of control even before the enormous increases in spending to cope with Hurricane Katrina and the persistently dire situation in Iraq (see "Disasters and the Deficit," next page). The administration's incompetent handling of the hurricane will exact its own price over and above disaster relief, as the White House tries to buy its way back up in the polls. The Republican Party's former reputation for prudent fiscal management is no longer merely compromised; it is ruined, perhaps for good.
Among Republicans in Congress squeaks of complaint are heard here and there. But the White House has drowned them out. Before Katrina, at any rate, the administration was still insisting that the budget deficit would fall over the next few years. That prediction might have been right if Katrina and Rita had not happened and if Iraq had come good—at least if one further assumed that no other emergencies would arise, that most of the administration's tax cuts would be reversed by the end of the decade (which the administration itself, of course, is determined to block), and that demographic pressures (which are causing the government to pile up vast liabilities for Social Security, Medicare, and Medicaid) would magically abate. On this side of the looking glass the deficit will not shrink unless something bold is done.
For those who find its budget forecasts unconvincing the White House has another line—one that slightly undercuts its assurances of fiscal responsibility. It is that the deficit does not matter. Economists have been predicting fiscal meltdown for years, officials point out. It has not happened and it won't, they say, even if the deficit sticks. The reason is that foreign investors just love this country's assets.
The resulting flow of funds—a global vote of confidence in American capitalism—means that the government can borrow without strain. Spend more, tax less, be happy.
It sounds like a confidence trick, and in the end it is—though, like all the best scams, it contains particles of truth. For much of the past decade private foreign investors have poured funds into the United States because they saw faster economic growth and better returns than were available elsewhere. As long as that kind of investment keeps flowing in, the deficit can be financed painlessly. Government spending still has to be paid for eventually, mind you—it is only a question of taxes today or taxes tomorrow. But a willing inflow of capital means that the eventual, inescapable cost to American taxpayers can be postponed at little risk.
Another thing helps. America enjoys the rare privilege of being able to borrow what it needs—currently on the order of $782 billion a year—mostly in its own currency. Countries heavily in debt usually have to borrow in a foreign currency. If they later get into trouble and the foreign-exchange market drives their currency down, the burden of their debt, measured in local money, weighs heavier, pressing them into an even deeper hole. But if the United States got into that kind of fix and the dollar fell abruptly, the value of America's debt would not rise. Instead the countries that had lent the dollars would see the value of their investments (measured in yen, say, or euros) fall.
As far as the United States is concerned, this is an excellent arrangement. With foreign lenders choosing to carry more of the risk, a credit-hungry America can afford to be less cautious.
But not this much less. If America were borrowing at half the present rate, it could probably relax. But $782 billion a year—more than six percent of GDP—is outlandish. Such reckless behavior has made America's privileged place in the world economy as much a curse as a blessing. Foreign capital is no longer voting as confidently for America. Private investors are spending less than before on American assets. Lately the slack has been taken up by foreign governments and central banks, which are pursuing not profit but doubtful policy goals of their own. (China's holdings of dollar reserves are already far greater than makes sense for China.) At some point these lenders are going to curb investment in American assets. Should this happen suddenly, here are some of the likely consequences: a spike in interest rates as the government is forced to find new takers of its debt, at dearer terms; a surge in personal bankruptcies and a sharp curtailment of spending among America's heavily indebted households; a stock-market crash; an increase in inflation; and a slide back into recession.
The present course of fiscal policy is not certain to end badly, but the risks are increasing. This summer, before Katrina, the economist Brad DeLong put the chance of a major U.S. financial crisis at 20 percent. The former Fed chairman Paul Volcker puts it at 75 percent within the next few years if we don't change our policies. Stephen Roach, the chief economist at Morgan Stanley (and a notorious pessimist), thinks it's about 90 percent. Whether any of these predictions is close to the mark is anyone's guess, but that's not the point. The point is that the chance of a bad outcome is substantial—and much higher than it needs to be.
Changing course now—before circumstances leave no choice—would be hard even if the administration believed it had to act. Starting from here, the combination of higher taxes and lower public spending required to bring the deficit down to manageable levels is politically daunting. Yet at the same time, Katrina has perhaps created a political opportunity to undo some of the fiscal damage this administration has wrought—by, say, curbing tax cuts and scaling back the Medicare prescription-drug bill.
Unfortunately, big-government Republicans see no need for such measures; they look at deficit hawks and see Chicken Littles. But this fiscal environment is more dangerous than any other America has faced in its modern history. Without corrective action the sky may fall.

Have a restful weekend; do your part to spread entropy.