In most countries that experience a fiscal crisis, there is no ambiguity about the situation.
The government is unable to sell debt at a reasonable interest rate. This probably coincides with a broader shift out of domestic assets, as smart investors read the writing on the wall or in the newspapers. The currency collapses and, often, inflation accelerates. The government is forced to slash spending and, cap in hand, asks for help from the world’s least popular ambulance service: the International Monetary Fund.
No part of this description fits the modern United States. Rates on government debt are very low, the currency isn’t depreciating rapidly and inflation seems stable. There is no imaginable circumstance under which the United States would need to borrow from the IMF. Yet this great land of innovation has undeniably invented its unique kind of fiscal crisis.
Or, to be more precise, we have reinvented the uniquely American way of ruining our fiscal affairs. At the beginning of the 19th century, Thomas Jefferson was obsessed with the idea that debt was bad and that the U.S.’s obligations — inherited mostly from the War of Independence — must be eliminated at all costs. (Jefferson himself had had some bad personal experiences with debt.)
Jefferson, James Madison, and their colleagues in the Democratic-Republican Party also wanted to shrink the size of the federal government, a reaction to the agenda of Alexander Hamilton and the Federalists.
In 1801, when Jefferson became president, the U.S. government embarked on a policy of cutting federal spending, including for the military. The Navy, in particular, suffered years of neglect or, in modern terminology, “lack of readiness preparation.”
What any economy needs by way of publicly provided goods varies with income level and stage of economic development. But the United States has always needed a robust military that is capable of protecting the country. And that’s not what remained after more than a decade of cuts in the early 1800s.
Unfortunately, the American fiscal way, then as now, was to combine excessive expectations with inadequate revenue. As a result, the dominant war-hawks faction in Congress sought and achieved a confrontation with Great Britain. It pitted the world’s biggest navy against a depleted fleet in a sorry state of repair. The contest wasn’t even close.
As a direct result, the British were able to trash Washington and burn the White House. The U.S. government didn’t default, or even come close. The fiscal crisis was a failure to deliver the public goods — defense — that the nation needed and expected.
Today, we have a budget deficit because revenue has been allowed to fall behind government commitments. This is the net result of the George W. Bush tax cuts, two foreign wars and the unfunded expansion of Medicare. Then, a financial crisis cratered the economy and further pushed down tax revenue while increasing unemployment and poverty. And, looking at decades ahead, healthcare costs (not just Medicare) threaten to undermine competitiveness or even sink the economy.
So how does the political system respond? Most recently, with a sequestration program of across-the-board spending reductions that undermine military readiness and cut essential programs that help poor children. And now, with a budget proposal from House Republicans that slashes Medicaid, about half of which goes to protect the health of poor children.