In response to Wall Street’s recent troubles, the investment banker Felix Rohatyn, a leading Democrat, is pushing for an infrastructure splurge, on the theory that massive new public investments in roads, bridges, rail and airports will generate positive economic returns and create well-paying construction jobs.  Of course, if the side effects from the housing slump continue to wrack the financial system, it may come to some sort of New Deal-style stop-gap employment scheme.  (Although it should be noted that, back in the Depression, Franklin Roosevelt infuriated the unions by holding the line on Reconstruction Finance Corporation and other works program wages at 15 cents an hour.)  Rohatyn’s idea closely resembles Japan’s ill-fated attempt to turn its economy around after 1996 through an undisciplined program of public works spending.  It didn’t work, and Japan’s debt is 180% of GDP and suddenly climbing rapidly — a very dangerous trend.

Indeed, if anything, historians may record that the most serious economic and financial consequence of the popping of the U.S. real estate bubble was that it set in motion forces that will culminate with the deflation of the largest bubble of all: the sovereign debt bubble.  As in Japan, where bad bank balance sheets were socialized onto the public balance sheet, we are now at a stage where our government is itself at risk of being overwhelmed by debt.  Who could have predicted that during the summer of 2008, the U.S. government would become the owner of the world’s two largest financial institutions (Fannie and Freddy) and it’s fifth largest insurance company (AIG), assuming several trillion in liabilities in the process?

In 2001, the bond rating agency Standard & Poors issued a study in which it projected a “march down the ratings scale” for the national debt of most industrial countries, because Europe, Japan and the United States had wildly over-promised on old-age benefits.  With huge deficits on the horizon, S&P reasoned that markets would, at some point, put an end to profligate borrowing by demanding larger and larger risk premiums for government bonds. 

It hasn’t happened yet.  Japan today borrows to fund its deficits at interest rates that are effectively less than inflation.  Government revenues amount to about 34 percent of GDP, and interest on the debt is less than 1 percent of GDP.  In other words, the interest rate that Japan is paying on its immense debts is a little more than one half of one percent.  Should markets now conclude that Japan is a default risk, investors will be reluctant to lend to it at risk-free rates.  For example, what if Japan were to face six percent interest rates, rates that are roughly what is being charged these days on short term corporate paper?  Its annual interest costs would jump by more than 10 percent of GDP, vastly increasing deficit pressures and making it likely that Japan’s borrowing needs would increase in order to pay its soaring interest costs. 

This is a death spiral, and it generally does not take long to play out.  As we have seen in the cases of Bear Sterns, Fannie Mae and AIG, such conditions can lead to bankruptcy with very little forewarning.

The problem is that Japan is not alone.  Every industrial country has made promises that it cannot possibly hope to keep, except by borrowing forever at very cheap rates — which, we know, is impossible.  The day of reckoning is coming, we just don’t know when.

Japan is now on a slippery slope.  It’s economy is deteriorating badly.  But, having exhausted its fiscal resources, its ability to further prime the pump is severely limited.  Monetary policy is similarly hobbled: its central bank discount rate is already negative.   Japan is essentially rudderless and powerless in a turbulent sea.  Should Japan sink into bankruptcy, it is likely to precipitate a contagion that, within a very short period, will sweep away much of what we, throughout the industrial world, take for granted about government’s capacity to shield us from the vicissitudes of life. 

These are dangerous times.  For those who wonder where the credit crisis could be taking us: watch Japan.

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America’s aging and health policies have set the stage for an epochal conflict of generational interests whose fallout could include rampant class warfare, exploding budget deficits, and ultimately much diminished retirement income security for those of us now in middle age.

The good news is that decisive legislative action—from hardnosed health cost containment to mandatory savings policies to significant near-term increases in the Social Security early retirement eligibility age—could do much to alleviate this risk. The bad news is that, absent a full blown economic crisis, the prospect of our taking such strong medicine is vanishingly small.

The roots of our lethargy lie in the short-term perspective that pervades society at every level. It is, of course, human nature to assume the future will be much like the past. And, suffice to say, the past has been uniquely favorable. Since 1990, America has created six new jobs for every additional senior citizen. Per capita old-age benefit spending may have surged, but the costs were painlessly absorbed by a rapidly expanding workforce.

Contrast this history with the Social Security Administration’s population projections for the next two decades. In the 2010s, we will add 1.7 senior citizens for every additional person in the traditional working ages (20-64). In the 2020s, we will add 8.4 new seniors for every potential new worker. Demographic factors that until now have mitigated the burdens of intergenerational transfers soon will greatly amplify them.

Individually, we baby boomers have done scandalously little to relieve our children and grandchildren of the escalating sacrifice these numbers imply. A Federal Reserve Board study found that, as of 2004, fully one-third of boomers had no financial assets at all. If current patterns persist, the typical boomer will enter a retirement lasting 21 years with financial balances sufficient to replace barely one year’s lost income.

As a group, today’s elderly are unquestionably needy: the median Medicare dollar is spent on households making less than 1.7 times the federal poverty threshold. Yet baby boom elders will be even needier. The Medicare Trustees estimate that premiums and co-payments for just the outpatient half of Medicare will increase from 29 percent of the average Social Security benefit in 2006 to 41 percent by 2030. In other words, Social Security—by far, the largest source of elderly household income—will finance a diminishing share of non-health consumption.

These projections may seem dire, but they are far from pessimistic. They assume, for example, that the rate of per capita health expenditure growth will fall 60 percent below the average of the past several decades, and stay there. They also assume that the large increases in taxes and/or budget deficits needed to cover boomer retirement costs will not adversely affect the economy.

As to what this scenario might this mean for our children, a new study by Sylvester Schieber—a leading retirement expert and President of Americans for Generational Equity—finds that, if boomer benefit bills are paid with taxes rather than deficits, and if workers save prudently for retirement, their non-health consumption will begin falling in the early 2020s. This decline will accelerate for as far as the eye can see.

We can quibble about the exact year when living standards will begin to fall, but not the trend. On their current path, baby boomers will be America’s first generation to leave its children and grandchildren worse off.

Winston Churchill famously quipped that “Americans can always be counted on to do the right thing…after they have exhausted all other possibilities.” The two “other possibilities” now on the table are class war and deficits.

The political left is convinced that, despite having the most progressive tax system in the developed world, America does not tax its affluent nearly enough. Yet there is little prospect that the projected growth in retiree spending can be financed mainly with new taxes on the 20 percent of households making over $100,000. Europe’s experience suggests that ballooning middle-class benefits will require ballooning middle-class taxes. In Germany, for example, the median household faces an effective tax rate of 47.5 percent versus roughly 21 percent (federal, state and local) in the U.S.

The political right has adopted the posture that, despite much evidence to the contrary, deficits have fewer adverse economic impacts than taxes. This argument will appeal to middle-class working families struggling to maintain their after-tax purchasing power. But it carries large economic risks. The Congressional Budget Office projects that deficit pressures—stated in 2007 dollars—will increase by $65-$90 billion a year between 2013 and 2020, and by $120-200 billion a year during the 2020s. At the low end of this range, the annual deficit in 2030 would be $2 trillion. It is unlikely that we could get to this point without a crippling rise in interest rates.

The numbers unequivocally point to a generational conflict in America’s future. It is not the kind portrayed in Christopher Buckley’s comedic best-seller, Boomsday, where angry mobs of youth storm gated senior communities and deface golf courses. Rather, it is a tragic conflict of generational financial interests: the prospective neediness of unprepared baby boomer retirees versus the limited capacity of future workers to support them without relinquishing their own claim to the American dream.

As a matter of ethics and self-interest, we boomers need to do our part to reconcile this conflict before it erupts into economic chaos and leaves everyone worse off. The worst thing we could do would be to throw in our lot with the same senior power lobbyists who knew about this crisis decades ago, but used their disproportionate resources to foist the full cost of adjustment onto the boomers and their children.

I have just participated in the greatest embezzlement in all of history. In my seventy plus years, I have never seen such a perfect crime. Like most other master criminals, I am heady with success and feel a need to brag. I kid you not — never before has one group appropriated as much money that belonged to another group in the history of crime. The victims, while they are increasingly suspicious, still do not know they have been had. It was literally and figuratively as easy as taking candy out of the mouths of babies.

Here is how we did it. The first rule of embezzlement is to find some naive patsy. We sensed forty years ago the younger generation was not paying enough attention to public policy, so we quietly found ways to maintain our lifestyle and charge it to the next generation. While those of you under 45 were preoccupied with other things, my generation dumped the largest load of debt on you that history has ever seen — and found ways to maintain our lifestyles on your credit cards.

A good scam needs a compassionate come-on. In our case, we developed a new word: “poor elderly.” To this day, most Americans do not understand that this is actually two words, and that “poor” no longer adequately describes the elderly as a class. There are, of course, poor elderly, many of them; but as a class the elderly have the most discretionary income of any group in America (except those in the age bracket of 55-65).

Next, we devised a number of systems that allowed us to charge our retirement to the next generation of Americans, who will wake up to find they are on the losing side of a Ponzi scheme. Like all good con artists, we relied on “trust.” We told them there was a “trust” fund for both Social Security and Medicare. Of course, this was a lie. There is no “trust” fund, in the normal sense of the word, because we take this month’s Social Security taxes from today’s workers and pay them to today’s elderly.

Then, we tell today’s workers not to worry — the money is being held “in trust.” In actual fact (as Senator Ernest Hollings of South Carolina has observed), they would be no better off if the fund was invested in confederate war bonds. The trust fund is a sham because it only contains IOU’s that tomorrow’s generation of workers will have to (mostly) pay off themselves. They will have to pay for both our retirement and a good part their own. Not bad. We succeeded in taking money from poor workers in St. Paul and sent it to wealthy retirees in St. Petersburg — and no one was the wiser. But, I have hardly begun.

The perfect embezzlement maximizes its take. We soon found there was money left over after paying the Social Security funds to today’s elderly, and we did not want to stop half way. What self-respecting crook would leave money lying in the bank vault after a robbery? Hell no. We completed the job by something called the “consolidated budget.” This allowed us to quietly take the Social Security funds left over to reduce our taxes by spending the money on current government services. Under the “consolidated budget,” we could legally “borrow” the money in the “trust fund” left over every year, and spend it on current government services; thereby, reducing our yearly taxes.

Virtually every year for the last 40 years we understated the yearly deficit and understated the total federal debt. Even though the official federal debt is approximately $9.5 trillion, the amount actually passed on to the next generation is closer to $50 trillion. My generation is master embezzlers. The entire scheme was done with clever accounting gimmicks, which allowed us to minimize our taxes and maximize our spending while we passed the bill on to the next generation. Like many victims of a crime, by the time they figure it out I will be long gone.

I have completely and totally spent the Social Security Trust Fund and left nothing in trust, absolutely nothing, for today’s workers to pay future obligations. They will have to either raise their taxes substantially, or dramatically reduce their benefits under the system. They have no other practical alternatives. They may, of course, try to do the same thing that my generation did and try to perpetrate the Ponzi scheme, but I doubt it will work. Young people catch on at some point. The true perfect crime only works once.

Every dime of the war in Iraq we put on our kid’s credit cards. Every dime of Katrina and Rita hurricane recovery we put “off-budget” and thus left it to our children to pay. Then we voted ourselves a substantial tax-cut, the only tax cut during a war in our national history. If anyone quoted Milton Friedman, “If you cut taxes without cutting spending, you are not cutting taxes, you are deferring them to your children”, we would quickly say we were “stimulating the economy” and change the subject.

The next generation will wake up to the magnitude of the fraud. They will recognize they are working long hours (or two jobs) and make less working than I make in retirement. Yet, every month they transfer money to me to pay for my health benefits. I have plans for that also. When they start to blow the whistle, I will say with shock and horror, “You can’t start a intergenerational war.” I will tell them about how hard I fought for this country (6 months in active service — most of it at the officer’s club bar). I will shame them by accusing them of breaking the “generational compact,” neatly covering the fact that it was really my generation who “broke” the compact by leaving them an unsustainable and insolvent system. Like any successful crook, I cover all my bases.

When health care costs became a larger factor in our budgets, we found a system to subsidize our health care costs at the expense of following generations. We called it Medicare. The average senior who turned 65 in 2000 got back $4 from today’s workers for every $1 that he/she paid into the system. Today’s retiree receives on the average a $100,000 subsidy toward his health care costs — from a system that is slated to go broke not far into this century. I am looking forward to playing golf and living high and sending much of the bill to today’s workers who make less working full-time than I make in retirement. Après moi, le deluge.

The story does not end there. My generation screwed up the savings and loan industry. What did we do to get out of it? We issued thirty-year bonds! Why should I pay for my mistakes when there is a gullible generation right behind me? Will I be here in 30 years? No. Will you? I leave it to my kids to pay off.

My wife and I bought our first house in 1963 for $11,900. Our first mortgage payments were $49 a month because we had a VA loan subsidized by the federal government. Everyone in my generation could buy his or her own home. It is estimated that thirty percent of the current workers below age thirty will never be able to own their own houses. It does not end there. I, to this day, get more money in housing allowance every year from the federal government than the poorest American. It is simple. I get to deduct my mortgage interest and real estate taxes, which is worth to someone in my income bracket more than the cash equivalent that any poor person in this state receives for housing. Ditto health benefits. By not taxing my health insurance paid for by my employer, I also receive more health benefits from the federal government than most poor children on Medicaid. I have recently passed Medicare Part D to help pay for my prescriptions. I have never seen a benefit that couldn’t be enriched.

Do I feel guilty? Well, occasionally. The other night I was standing in the line for the movies, getting a senior citizen discount. There was a struggling young couple in front of me who were wondering how they were going to pay the baby-sitter. My wife and I had driven to the theater in our fancy foreign car from our debt-free house — but we got a $6 discount from the price the young couple paid.

I try not to spend too much time thinking about it. I keep busy. Right now, I have to go down to the State Legislature to lobby for free fishing licenses for seniors. Why not? We already get free state park admission. See you around.

Readers are encouraged to review the recent commentary, “British bomb plot and Michael Moore-style health care” by Mark Steyn, a contributor to the reliably conservative — and usually informative — op-ed page of the Orange County Register.

Steyn delivers a depressingly two-dimensional analysis: Britain’s latest would-be suicide bombers were all immigrant doctors from the Middle East. And Britain’s regrettable over-reliance on low paid immigrant medical labor is an outgrowth of its underfunded national health system — the kind of system we Americans would be wise to avoid. One is left to conclude that if Americans start paying doctors less, we too might have to import terrorist docs. Horrifying examples of dirty hospitals and stinting care follow.

Since the US is the only developed country without a national health system, examples of waste and mismanagement in such systems would be easy to find even if they were comparatively rare. But, for the sake of argument, let’s say that such problems are as legion as critics suggest. They still don’t tell the whole story. Conservative angst over the imagined and real problems with national health systems obscures a strategic fact: Americans pay twice what Brits do for care that, by many measures, isn’t as efficacious as that received in the UK. In fact, as a share of GDP, the taxpayer funded half of US health spending exceeds total UK health spending, public and private. Meanwhile, America’s health costs are rising so rapidly off of such a high base that government’s share of the US economy is projected to surpass Britain’s by the 2040s.

Steyn is right: British docs are paid less than US docs. But the OECD comparisons show that the UK has one of the world’s most generous doctor pay scales. Along with Canada and Australia. See the connection here? Insular Japan — where English is not widely spoken — doesn’t have this problem. Japan’s medical pay scales are far below Great Britain’s, but it spends a similar share of GDP on health ( 8.4%). This means that more money is left over for actual services. Indeed, despite having a population age structure that is already older than America’s is projected to be in 2050 (when US health expenditures will be approaching 35 percent of GDP), Japan manages to have cleaner hospitals and higher numbers of hospital beds and gadgets like cat scanners per capita than the high-spending US. An informal survey of Washington DC area hospital personnel administrators finds that radiologists hereabouts make about $500,000 on salary, because in private practice they will typically earn $700,000. A Japanese radiologist would be lucky to earn one third of that.

It is the high pay scales in the US that are causing the migration of English-speaking MDs to the US, and forcing the UK to rely on Islamist immigrants to fill the gap. Imagine how nice it would be to have your medical school bills paid by the British government and then to trundle over to Northern Virginia and only have the inconvenience of certification as your obstacle to an added $150K a year in annual income. The lesson from the UK terrorist docs is that America’s health spending orgy has international ramifications that extend well beyond the health sector.

Of course, anyone with money in Great Britain can buy gold plated health care — not like in Canada, where, theoretically, they can’t (except that 90 percent of Canadians live within 100 miles of the US border). It’s the average Brit, who wants cheap, basic care — perhaps because he doesn’t earn much, doesn’t save much, and doesn’t want to pay a larger share of his income in taxes — that make do with the basics. And those basics are not as bad as conservatives make them out to be. For all of the hyped-up horror stories, life expectancy and rates of morbidity are better in the UK than the US for all but the oldest age groups. Why is it that conservatives insist that everyone — especially the elderly — have unrestrained access to extravagantly priced health care, when those same conservatives aren’t willing to foot the tax bill?

The Boomers are coming. Comptroller General David Walker - the closest thing America has to the original Paul Revere - has been barnstorming the country warning about the intergenerational implications of budget deficits and “unfunded liabilities” under Social Security, Medicare and Medicaid. A new study by AGE president Sylvester Schieber lends substance to these concerns . Schieber finds that raising taxes to cover exploding benefit promises could cause today’s middle-aged generation – the baby boomers – to leave a legacy of falling living standards to its own children and grandchildren. Frighteningly, doing the “fiscally responsible” thing, and covering current-law old age benefit liabilities with higher taxes, will cause the per capita consumption of working-age Americans to begin declining in 2025. While raising taxes may be fiscally responsible – and may well be preferable in the long run to runaway deficits - Schieber shows that, by itself, it is not generationally responsible.

Deficits are a time tested way to pass along costs to future generations. The Constitution (Article I, Section 8 ) requires that Congress and the president honor the nation’s public debts. This means that short of paying off the debt, we and those who come after us must pay more or less perpetual interest on every dollar that we spend today but don’t tax ourselves to cover. The main constraint to putting all of our bills on the national credit card is the so called interest rate response. If deficits appear to be permanent (that is, nothing is being done to limit them) and growing, eventually the bond markets will begin to price in the prospects of default (or inflation, which itself is a form of default, since it reduces the real value of future interest payments). The rise in interest rates not only causes the deficit to grow faster (because debt service equals interest times principle), but slows GDP growth, undermining prosperity.

At 37 percent of GDP in 2006, America’s national debt hovers just above the postwar average of 36 percent, and far below the EU average of roughly 70 percent. Relatively speaking, we’re still in pretty good shape. But consider the predicament of Japan or Italy, where the national debt is already high. When a nation’s is debt equal to 100 percent of GDP, each one percent rise in the interest rate pushes up annual outlays for debt service by one percent of GDP. For heavily indebted countries, rising interest rates can initiate a vicious spiral in which rising debt service costs result in larger deficits, which then push up the interest rates, and so on.

Indebted nations need high savings rates so that they can “borrow from themselves” rather than rely on foreign capital inflows. This is because, in low savings countries, domestic interest rates – and hence economic growth – are vulnerable to exchange rate risk. If foreign lenders become concerned that the dollar may weaken relative to other currencies, they could reduce or reverse investment flows, making capital scarce and forcing up interest rates accordingly. Inflation may trigger these concerns. But so can ballooning trade and current account deficits, such as those we are experiencing today.

The take-away is that runaway deficits pose an enormous economic and financial risk to America’s aging baby boomers. A lifetime of accumulation and diminished capacity for employment make older populations more vulnerable to an economic upheaval that undermines the performance of the stock, bond and real estate markets. In the Great Depression, older generations lost the most in the downturn but gained the least from the subsequent recovery. By 1935 there had been a vast shifting of fortunes away from the contemporary old – thereby creating the political rationale for Social Security and Medicare, the very programs that now threaten to spark a new round of economic upheaval. History may be on the verge of an ironic twist.

Rather than risk falling living standards in old age – which the average boomer retiree will be ill-prepared to absorb – many will be tempted to do the fiscally responsible thing, and impose falling living standards on their children and grandchildren. The Schieber study shows that this outcome is very much in prospect.

The late management guru Peter Drucker once described such phenomena as “the future that has already happened.” The demographic and financial momentum for a generational train wreck is extremely powerful, and it is gathering speed. Is it too late to avoid this unfolding tragedy? What can be done to avoid it? AGE welcomes your comments. PSH