There’s no way around it: the sum of all debt in the U.S. economy is large. The government budget deficit is about to surpass $10 trillion (or about 75% of GDP.) To compare, the annual value of all crude oil traded in the world, some 100 million barrels a day, is about $3.4 trillion given recent high prices. Such a massive deficit will not shrink unless the Bush tax cuts are repealed and a national consumption, sales or value-added tax is implemented. The next president of the United States will have no other choice.

But that’s only part of the picture. Private debt, especially consumer debt, must also be reduced. The Federal Reserve reports that, as of end of June 2007, Americans owed $2.47 trillion in consumer debt, some 18% of GDP or roughly a year’s worth of American oil imports. That number includes all installment, revolving, and credit card debt but excludes $7 trillion in mortgage debt. Credit card debt makes up some 5% of annual household income, even though 25% of all households have no credit cards. Other reports indicate that three out of every ten consumers are late payers and repay their debts more than 60 days late. American consumers pay for $41 of every $100 of their purchases with credit, not cash, check or debit cards.

Thus the American economy is heavily leveraged against its future income, and further consumption is the only remaining locomotive of the economy. Alas, such consumption habits have reached an alarming level. The Commerce Department reports that since 2005, Americans have “negative savings” -- they spend more than their after-tax earnings, either dipping into their savings or borrowing more. The last time that negative savings happened was during the Great Depression. Live now, pay later! From abroad, it appears that the American consumer is feeding his habits with a trade deficit while the government borrows new cash to pay interest last month’s purchases. What happened to fiscal discipline?

The asset inflation of the last 15 years or so is blowing more air into the balloon. It might seem useful for the short-term, but in the long run this tactic has harsh residual effects. An indebted government welcomes asset inflation, and thus currency devaluation, because it makes it easier to repay long-term government debt. However, the U.S. ought to learn a lesson from the Japanese experience and their unchecked asset inflation during the 1980s: it was followed by a decade-long recession. Japanese share prices have yet to return to high levels of that era, even though the Japanese are fiscally conservative and a nation of savers.

Given the large size of the American economy, each of these issues raises eyebrows in other developed countries, where private sector debt is cautiously managed and company bankruptcies are considered shameful scandals.

In all, I estimate that to reverse the American budget deficit will absorb about 2% of GDP for at least three years, and to reverse consumer and mortgage debt trends will cost another 4-5% of American GDP. Reversing asset inflation trends will be significantly more expensive. Without taking such painful steps, it will be difficult to envision higher exchange rates in the next 4-5 years. The devaluation of the dollar is not a passing market correction; it’s a non-confidence vote from global markets on the American economy. Foreigners who noticed these challenges before most Americans did may be wondering whether the Americans’ post-Cold War “peace dividend” was nothing more than debt.