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TONY JONES: Well, the US is not just labouring under a record trade deficit, there are warnings tonight that its budget deficit could precipitate a Latin American style financial crisis.

Influential economist Paul Krugman says the US will face a severe downturn before the end of the decade unless the $500 billion fiscal debt is rectified.

In his latest book, The Great Unravelling, the Princeton University economist is calling on President Bush to abandon his program of trillion dollar tax cuts, otherwise, he claims, there may not be enough funds to pay for the waves of baby boomers who will soon retire.

I spoke to Paul Krugman a short time ago.

TONY JONES: Paul Krugman, history proved your predictions right over the Asian financial crisis.

You're now warning essentially that the engine of the world economy, the United States itself, is heading for a South American style financial crisis.

What's the evidence for that?

PROFESSOR PAUL KRUGMAN, PRINCETON ECONOMIST: Well, basically we have a world-class budget deficit not just as in absolute terms of course - it's the biggest budget deficit in the history of the world - but it's a budget deficit that as a share of GDP is right up there.

It's comparable to the worst we've ever seen in this country.

It's biggest than Argentina in 2001.

Which is not cyclical, there's only a little bit that's because the economy is depressed.

Mostly it's because, fundamentally, the Government isn't taking in enough money to pay for the programs and we have no strategy of dealing with it.

So, if you take a look, the only thing that sustains the US right now is the fact that people say, "Well America's a mature, advanced country and mature, advanced countries always, you know, get their financial house in order," but there's not a hint that that's on the political horizon, so I think we're looking for a collapse of confidence some time in the not-too-distant future.

TONY JONES: When you say the not-too-distant future, what does that mean?

We know there may be a crisis in paying, for example, in social security...

PROFESSOR PAUL KRUGMAN: What I envision is that at some point, we have about 10 years now until the baby boomers hit the United States.

The US even more than other advanced countries has a welfare state that's primarily a welfare state for retirees.

We have the huge bulge in the population that starts to collect benefits and earn the next decade.

If there isn't a clear path towards fiscal sanity well before that, then I think the financial markets are going to say, "Well, gee, where is this going?"

I think, where in that 10 years the crunch comes, I don't know.

I think there's a real possibility that next year or one or two years from now, when they see that actually the same irresponsible tax cuts as the solution to everything continue, we might have a crisis that soon but more likely towards the end of the decade.

TONY JONES: Let me ask you this - just in the short-term, given today's policy settings and the ones that are going to prevail, we assume, through the election period, what's likely to happen to interest rates?

PROFESSOR PAUL KRUGMAN: Right now, long-term interest rates, short-term interest rates, I think, are going to stay where there are, which is not far above zero, right through the election and probably beyond because that's directly under the control of the Federal Reserve.

The economy is weak for the time being.

Job creation is essentially non-existent.

Long-term interest rates which should reflect all these things are actually quite low right now and it's an interesting thing when you try to talk to people in the bond market, why, you ask, doesn't the deficit worry you?

Don't you wonder that there's going to be a financing crunch?

And they say: "Well, we believe that next year Bush or whoever is in the White House is going to get responsible."

And you ask them: "What evidence do you have for that?"

And they say: "Well, I don't know but it's always happened before."

So right now again, the bond market is reflecting the credit built up in previous responsible governments.

TONY JONES: Actually the bond market's quite interesting because for the present moment there seems to be a huge influence on the US economy from the Asian central banks.

Is that risky?

PROFESSOR PAUL KRUGMAN: Well sure.

Although, I'm not sure that it's particularly riskier than a lot of other things. But yeah, we have this, I didn't say this, but we've got twin deficits.

We've got a huge budget deficit and an equally large current account deficit.

And if you ask, "How are we financing the current account deficit?", well that's a story.

A few years ago it was foreigners investing in the United States.

It was Daimler buying Chrysler, it was people investing in the strength of the US economy.

These days it's Asian central banks buying up US Government debt because they're trying to keep their currencies weak against the dollar and this can't go on forever.

TONY JONES: Your detractors - and there are quite a few of them on the Republican side of the equation - they're accusing you of scare mongering?

PROFESSOR PAUL KRUGMAN: The first thing to say is to look at what some of those same people were saying in the middle of the Clinton years when the deficit was substantially smaller as a proportion of GDP and they were carrying on about what a bad thing it was.

The other thing is the comparison.

The only time post war that the United States has had anything like these deficits is the middle Reagan years and that was with unemployment close to 10 per cent.

A lot of that was a cyclical thing which would go away when the economy recovered.

Also the baby boomers were 20 years younger than they are today.

If you look at the actual fiscal situation, it's much, much worse than it was even at its worst during the Reagan years. One way to say this is we have social security which is a retirement program which viewed on its own is running a surplus.

If you take that out of the budget then we're running at a deficit of more than 6 per cent of GDP and that is unprecedented.

TONY JONES: One of your fiercest critics, Donald Luskin, seems to fear you because of your very credibility and your plausibility.

As he puts it, you're the most "dangerous liberal commentator in the United States".

He says he once admired you but now he actually runs a website called the Krugman Truth Squad?

PROFESSOR PAUL KRUGMAN: Yeah.

Well, look this is good.

Something I used - let them hate as long as they fear.

I think the point is, let me quote Harry Truman: "I give them the truth and they think it's hell."

I don't think I've been saying anything that isn't quite straight forward.

It's just arithmetic but it's been stuff that a lot of, very few journalists have been willing or able to say.

TONY JONES: It's a bit more than arithmetic though, isn't it?

Would you agree with the proposition that you're slowly transforming yourself, in a way, from a pure economist into also something of a political activist?

PROFESSOR PAUL KRUGMAN: Well, yeah, I mean, it's not what I intended. But I came in writing as a journalist, writing occasional columns in the 90s, mostly about economical fears with a political tinge.

I came to the New York Times intending to do pretty much the same thing.

But then it became clear very early on that the President of the United States was irresponsible and dishonest on matters economic and it turned out that what I learned there was true of other kind of policies as well.

So, I was forced, if you like, just by the arithmetic of understanding how the budget works into a much broader critique of this really kind of scary thing that's happening to my country.

TONY JONES: Let's look a little bit at that broader critique that you outline in The Great Unravelling, your new book.

You claim that President Bush is part of the radical right and that America has become a revolutionary power.

How did you come to those conclusions?

PROFESSOR PAUL KRUGMAN: If you look at the policies and in a variety of areas, they're not within the range of normal partisan divides.

That is, Republicans always want lower taxes and Democrats a bigger state.

There are always disagreements about how strong environmental policies should be, but we're really way outside that now.

We're talking about repeated tax cuts in the face of enormous deficits and in the face of war.

Never done that before.

We're talking about a shift towards unilateralist foreign policy.

We've just gone to war without significant allies other than the UK to destroy weapons that didn't exist.

This is something that's kind of unique.

We're seeing a radical breakdown of the separation of church and state in a lot of policy issues.

This is something that's really outside normal politics and then if you just look at the political history, where do these people come from - you discover that there is a network of think tanks, organisations, funding sources, radical activists - which really, it's more than just an ordinary swing of the political pendulum.

If you like, the vast right-wing conspiracy isn't a theory, it's quite clearly visible to anyone who takes a little care to do his home work.

TONY JONES: One of those think tanks, of course, is the Heritage Foundation which was set up in a way to boost a series of ideological positions on the economy, on the social front and is now, you say, virtually running, to some degree, a lot of economic policy and one of the things they say, for example, is that social security and Medicare are violations of basic principals?

PROFESSOR PAUL KRUGMAN: That's right.

Heritage is central.

Heritage is in the middle of everything.

Almost every - if you like, the WAPs, the policy types such as they are, as opposed to the politicos - but the WAPs in this administration are almost all connected with Heritage or American Enterprise Institute but one or both of those.

And Heritage very clearly in its letters to fund raisers reminds them that our goal is to get rid of these programs, that we need to get rid of the legacy of the new deal on the great society and that means social security and Medicare.

TONY JONES: Now here's another quote from your book: "A revolutionary power does not accept the legitimacy of the state."

PROFESSOR PAUL KRUGMAN: There's a very hardline view.

There was actually a kind of revealing moment recently - Bush gave an interview, was more or less dragooned into an interview on Meet The Press and the interviewer said: "Well, what if you lose the election?"

And he said: "I'm not going to lose the election."

And the interviewer said: "But what if you do lose?"

He said: "I'm not going lose the election."

The possibility that they just would not regard it as a legitimate thing if someone else were to take power.

Quite a few people as part of the Republican movement have said that God chose Bush to be President.

I don't know whether they would accept the idea that mere mortal men should choose for him not to be President for another four years.

TONY JONES: You also link the personal fortunes of George Bush and Dick Cheney to what you called the epidemic of corporate malfeasance.

Are you suggesting that, in a way, their business ethics somehow leaked out into the rest of the corporate world or that they're just representative of it?

PROFESSOR PAUL KRUGMAN: Oh no, they're representative of it.

Let's be clear.

Most of the explosion of corporate malfeasance really took place during the 90s.

It took place with Clinton in the White House, which is not to say that he caused it.

In fact, you could say a lot of it happened despite some mild efforts on the part of Clinton to stop it.

But the point is that you ask when Bush says, "I want to reform corporations," is he credible?

Well, you have to look back and say, "Gee his own personal fortune arose, in large part, through deals that look an awful like Enron."

TONY JONES: Nor do you spare Alan Greenspan, the chairman of the Fed Reserve.

I always thought under the Clinton years or during the Clinton years he was the steady hand on the tiller.

You seem to refer to him these days as a partisan hack?

PROFESSOR PAUL KRUGMAN: Well, here's a special case.

I mean, the governor of the central bank has a terribly important job, enormous responsibility and power.

He's not an elected official.

This is an agreement that we've all reached - that this is a good thing to do because monetary policy is too easily politicised.

Best to have it in a technocrat.

In his role as a technocrat Greenspan has done a good job, not as stellar a job as his admirers will tell you but he's done a very good job.

There's an obligation that goes with this which is to stand above and outside the political fray.

Greenspan did that during the 90s.

But no sooner was Bush in office than Greenspan threw his weight behind tax cuts.

He actually went to Congress and argued that we need tax cuts because otherwise we're going to run excessively large budget surpluses and pay down our debt too quickly.

Which he shouldn't have done in the first place.

This was violating the role.

Then, of course, when it turned out to be completely wrong.

Instead we've plunged from surpluses into huge deficits, he has now said, "Well, I don't think we should rescind the tax cut, instead we need to talk about cutting social security benefits."

That's injecting himself into politics in a very partisan fashion.

TONY JONES: You essentially claiming the Fed is no longer independent?

PROFESSOR PAUL KRUGMAN: Well Mr Greenspan is acting as a partisan figure.

He is acting as somebody who is doing whatever he can to support the agenda of this right-wing movement that is now running a large part of the Government.

I think that the star at the Fed is as good as ever.

My belief is that if you were to promote one of the other governors to chairman of the Fed we would be back to business as we've had it before.

I don't think everybody has been corrupted but I do think that Mr Greenspan has gone very far - basically has abused in his position, in a way, that's no longer recoverable.

TONY JONES: We will have to leave it there.

Paul Krugman, we thank you very much for taking the time to come and join us tonight.

PROFESSOR PAUL KRUGMAN: Well, thank you.

another good interview this week..