In your opinion, what can the US do to avoid this sort of crisis? With such a large deficit and unimaginably huge unfunded liabilities in the future such as medicare, medicaid, social security, etc., how can the US ever have a balanced budget? People say cut entitlements, but they fail to see just how much money the fed has "loaned" to both domestic and foreign corporations and banks. Even if it cut all of the entitlement programs (which would be a disaster) that still wouldn't cover it all. Not even close. And then there is the unemployment rate, and the lack of growth. It comes down to basic accounting: either the US needs more growth or less spending, preferably both. However, even if all of these things happened, the dollar is still losing ground and many foreign governments are dumping the dollar for more secure currency. To me, this looks like impending doom. But to most people, they seem to find hope- but hope in what, exactly?
Evanescence,
There is no silver bullet. The process will take a lot of time. The first step would be to slow the increase in the rate at which the nation's debt has been growing. The second step would be to stabilize that debt. The last step would constitute debt reduction. In doing so, there will always be a level of social welfare, investment, national security, among other functions, that the federal government needs to undertake. The federal government cannot be "run like a business" because the interests in governance are far broader than those of a business (social, economic, financial, safety, etc., vs. financial/economic for businesses). The government can apply some lessons i.e., become far more focused and efficient.
IMO, a credible fiscal consolidation strategy will have to involve:
1) Social security reform: A fairly simple actuarial problem. Current retirees would largely be held harmless. The eligibility age would be raised for future retirees and then pegged to changes in life expectancy. The payroll tax cap would be raised to the original level (share of income) and pegged that share of income. Benefit increases (for future retirees) would be tied to the cost of living, not wages.
2) Medicare/Medicaid: Very complex. Savings would depend on fundamental health care reform. Unless the health system's excessive cost growth problem is addressed, Medicare/Medicaid reform won't be viable. One could convert the programs to vouchers, but then the problem would be that the recipients' vouchers would provide increasingly less coverage (underinsurance/uninsurance) on account of rapidly rising health costs. One could impose strict budgeting, but that would lead to rationing based on expenditures (effectively simulating underinsurance/uninsurance). As a result, neither vouchers nor strict budgeting would fix the programs in the absence of fundamental health reform, except at unacceptable costs of effective underinsurance/uninsurance.
Policy reforms would include permitting Medicare to negotiate drug prices, etc. In business, firms use their purchasing power to leverage better deals. It is remarkable that Medicare is not permitted to do so. Reimportation of drugs should also be permitted. Prohibitions are anti-competitive and they essentially protect price disparities from arbitrage. In the securities markets, if a share of a company's stock is trading at a higher price in London than in New York, one would witness buying in New York/selling in London (profitable) until the price disparity disappears. Such a practice is barred when it comes to preventing reimportation of drugs.
Fundamantal health reform would be more complex. Both the demand and supply side would need to be addressed. That means addressing incentives that currently exist for overutilization (copayment structures could be made flexible). It means dramatic changes in technology procurement. It also means reducing competitive barriers i.e., making it far easier for foreign medical providers/hospitals and physicians to practice in the U.S. Other reforms would include tort/medical malpractice reform, licensing reform, etc.
3) Tax reform: The tax base should be broadened (elimination of various deductions) so as to generate additional revenue. Even popular deductions should be on the table. In general, if all businesses cannot receive the same deduction, such a deduction is preferential. It distorts economic activity.
My guess is that a credible fiscal consolidation program could stabilize federal debt relative to GDP within 5-10 years. Afterward, a gradual reduction relative to GDP, and later absolute terms, could commence. However, a lot will depend on economic growth and interest rates. Historic experience with fiscal consolidation has shown that consolidation that is largely (but not wholly) spending-driven (2/3 or more of the savings come from spending changes) creates the least economic drag in the short-term. Policy makers should be careful to distinguish between expenditures that are mainly consumption and those that are investments (create future value). Indiscriminate treatment could also tend to cap the nation's long-term growth potential. More robust economic growth leads to faster revenue growth. At the same time, the program has to be credible in terms of substance and perceived as credible by the public. When credibility is lacking or perceived to be lacking, interest rates would wind up higher than they would otherwise be. Higher interest rates would slow economic growth (higher cost of capital) and increase debt service costs. A measure of revenue increases can add credibility, as it could take away concern that a country might not be able to carry through with a magnitude of spending reductions that could be viewed as unrealistic.
Finally, the recent debt ceiling debate revealed enormous problems in the nation's political process. The extent of dysfunction has elevated risks going forward. The other big issue is structural problems in the nation's economy. Unless those issues are addressed by both the public and private sectors, the nation's long-term growth rate will be lower than it would otherwise have been. A 2.5% sustainable long-term growth rate vs. the 3% figure widely assumed in many fiscal projections, would essentially wipe out a significant share of the savings in the recently enacted debt ceiling legislation (revenues would underperform and stabilizers such as unemployment costs would be higher than expected).