New York Times oped, May 11, 2004
If soaring deficits are such a big problem, why haven't long-term interestrates also soared? Could it be that John Kerry is wrong when he says thatthe Bush deficits threaten to become a "fiscal cancer that will erode anyrecovery and threaten the prospect of lasting prosperity in our nation" -and Dick Cheney is right when he purportedly told Paul O'Neill that"deficits don't matter"? A lot hinges on the answer - for example, whether74 million aging baby boomers will get the Medicare and Social Security they're counting on, whether millions of homeowners with variable-rate mortgageswill be able to make future payments on their homes, whether the privatesector will continue to get the capital it needs, and whether America facesan economic Armageddon if the Bush administration doesn't mend itscut-taxes-and-spend-like-a-drunken-sailor ways.
The Democrats have become the eat-your-spinach party, preaching the virtuesof fiscal restraint, while Republicans invite us to a free lunch. And what afeast it is! Upper-income Americans have been treated to vast tax cuts, withpromises of even more are to come. Government spending, meanwhile, hasballooned - including Medicare drug benefits, farm price supports, andpork-barrel projects of every size and dimension. This year's deficit,according to the White House's own estimate, will be $521 billion - four anda quarter percent of the total economy. And then it's at least $500 billionas far as the eye can see. If Bush succeeds in making his tax cutspermanent, reducing the alternative minimum tax, and summoning tens ofbillions more to war against terrorism, future deficits will be much larger.
Most mainstream economists, like Old Testament prophets, speak of a day ofreckoning. Even Alan Greenspan, former enthusiast of the Bush tax cuts, nowissues grave warnings. Surely this cannot go on, they all say. Surely bondtraders will take their revenge. Long-term interest rates will rise sharplyas lenders foresee that all this public borrowing will use up the limitedsupply of private savings. If the market is behaving rationally, long-termrates would already be rising in anticipation of crunch time. Who in theirright mind would lend dollars today, to be repaid in three or five or tenyears, without insisting that debtors pay substantial interest? John Kerry'seconomic plan - rolling back the Bush tax cut for people earning over$200,000 and reestablishing strict "pay-go" rules requiring that any newspending be offset with other spending cuts or new revenue - is basedsquarely on this mainstream view.
Yet, curiously, Wall Street seems to have given the administration a freepass. So far, the vast increase in government borrowing made necessary inorder to fund the budget deficit hasn't affected long-term interest ratesall that much. The benchmark 10-year note yield is still below the averageyield of 5 percent in 2001, when the nation last posted a budget surplus.What gives?
Capital markets do not always behave rationally, of course. Perhaps bondtraders aren't paying attention to the gathering storm. Maybe they've beendistracted by the Fed's low short-term rates. Maybe they're Republicans. Yetthere's another possible explanation, consistent with an exercise ofcomplete economic and political rationality. Bill Clinton, and now JohnKerry, have taught the bond traders on Wall Street an important andcomforting lesson: No matter how big deficits grow under Republicanpresidents, eventually a Democratic president will come along to clean upthe mess. That confidence is keeping long-term rates down, despite thecurrent out-of-control deficits.
More than a decade ago, you'll remember, the federal deficit was over $300billion as far as the eye could see - approaching 5 percent of the economy.Clinton and congressional Democrats reversed this profligate trend byslashing spending and raising taxes. The strategy was hard to swallow, andnot at all popular - not a single Republican member of Congress voted forClinton's 1993 budget. Some of us in Clinton's cabinet thought he had gonefurther than he needed to; there was too little money left for education,job-training, health care, and all the other things Clinton had promised andthe nation needed. But there is no disputing that the plan had the intendedeffect. Deficits that had ballooned under Ronald Reagan and the first GeorgeBush were brought firmly under control. Bond traders breathed great sighs ofrelief. Wall Street beamed brightly.
John Kerry has responsibly decided to take the same route. If he becomespresident next January, he will inherit a budget mess not unlike the messBill Clinton inherited. And Kerry has already committed himself to followClinton's lead, and impose fiscal restraint. He has already scaled back someof his more ambitious spending plans, and has somberly told his Democraticaudiences - as Clinton told his - that we must first get our fiscal house inorder before addressing the larger the needs of our society.
Undoubtedly, Kerry's resolve has contributed to the bond traders' calm. Inthe event that Kerry is not elected and Bush gets a second term, the fiscalmess will become substantially worse. But bond traders will still takecomfort in the knowledge that another Democrat will likely come along toclean it up, eventually.
You see, Democrats and Republicans are engaged in the economic equivalent ofNixon going to Peking: Republican presidents can get away with utterlyirresponsible fiscal policies because there's no one to their right who willmake much trouble for them. Democrats can get away with fiscal austeritybecause there's no one to their left who will make their life difficult. Butthe irony should not be missed. Kerry's promise of fiscal responsibilitymight just save George Bush's presidency.
Robert B. Reich's new book is "Reason: Why Liberals Will Win the Battlefor America," (Knopf).
