Neither Crash Nor a Cure, Budgeteers Bring Forth a Yawn

For weeks the eyes of the world were fixed on the congressional and Administration budget conferees. A crisis of confidence, said many observers. Last chance to fix the deficit, said others. On some days, little progress was reported and on those days the nation--or at least the media--shuddered. Would the conferees make significant budget cuts and so restore confidence to the shaken financial markets? Finally, the conference presented its results, and last week Wall Street neither crashed nor soared. It yawned.

What Reagan said of the majority report on the Iran-Contra affair--that they labored and brought forth a mouse--could be said with more justice of the budget negotiators. With $23 billion in cuts already assured by the Gramm-Rudman-Hollings Act, a month of face-to-face talks involving the most senior U.S. political leaders resulted in only $7 billion of additional 1988 cuts. More cuts were promised in 1989, after the election. We shall see.

The $7 billion was more illusion than reality. Federal budget estimates are just that--estimates. A strong economy means more income and fewer expenses for the Treasury, and a recession means the opposite. Seven billion dollars, less than 1% of federal spending, is simply too small a number to have any significance. In October, the deficit was $5 billion larger than originally estimated--virtually wiping out the ballyhooed $7 billion.

Although Washington presented its budget talks as an emergency response to the stock market meltdown, budget talks were in the cards long before Oct. 19. Across-the-board cuts totaling $23 billion under Gramm-Rudman were scheduled if Congress and the President could not agree on a deficit-reduction program by Nov. 20. Under Gramm-Rudman, cuts were to be equally divided between the military and domestic budgets. Since the President was unwilling to accept $11.5 billion in defense cuts and Congress felt the same way about domestic programs, tough negotiations were anticipated long before the market crash.

While legislators and Administration officials welcomed the chance to pose as the nation’s saviors in an economic crisis, the market downfall had little to do with the decisions reached. The deal’s general outlines--slightly higher taxes and slightly lower spending levels--had also been clear since Gramm-Rudman was enacted. It has been evident since 1981 that politicians of both parties lack either the vision or the courage to attack portions of the federal deficit that make the most trouble.

Republicans would like to cut middle-class entitlement programs but they fear the wrath of voters. Democrats dream of pruning what they regard as unnecessary weapons programs but they too lack the stomach for the resulting political fight. It will take more than a stock market crash to break this logjam.

In any case, it is far from clear that the federal deficit had anything to do with the crash. The deficits, after all, have been mounting for years and during most of that time stock prices rose regardless of the federal deficit. In fact, the federal deficit had begun to shrink in the months before the crash and the Gramm-Rudman process insured further cuts were on the way.

It is also unclear that cutting federal spending is the wisest course in the wake of a crash. The time to cut the deficit was 1984 and 1985, when the economic expansion was young. Now that the expansion is 59 months old, and the threat of recession looms on the horizon, cutbacks in federal spending or major tax increases could bring on a recession. The last President to cut federal spending in the wake of a market crash was Herbert Hoover.

What markets want from the U.S. government is decisiveness. The twin deficits--budget and trade--frighten investors around the world but not as much as the third deficit: the leadership deficit. The inability of U.S. political leaders to address either the budget or trade question has led to a loss of faith in the future of the U.S. economy.

Since the first quarter of 1985, when the trade deficit stood at $25 billion, the dollar has steadily dropped and, just as steadily, the trade deficit has grown--to $40 billion in the most recent quarter. In an eerie imitation of Hoover, economists have been saying for two years that an improvement in the balance of trade was “just around the corner.”

Perhaps. But devaluing the dollar to balance the trade deficit is using a blunt instrument for a delicate task--like a tire iron for brain surgery. Making U.S. goods cheaper in foreign countries makes them easier to sell, but it also means we must sell more goods to pay for imports.

The falling dollar also raises the cost of capital for U.S. companies. Investors want higher interest rates to compensate them for the risks of holding a weak currency: American blue chip corporations have to pay twice as much interest as German and Japanese companies to attract investors.

Many U.S. trading partners--such as Hong Kong, Taiwan and Korea--have pegged their currencies to the dollar. Others, like Mexico, have devalued their currencies against it. In the early 1930s, the world’s trading nations got involved in a round of “competitive devaluations,” each country trying to gain an advantage by lowering its currency value against its rivals. Economically, devaluing the dollar works as a tariff on imports. Pushing down the dollar cuts the purchasing power of the U.S. consumer. The result: less buying power in the hands of purchasers, less demand for the products of business and more chance of recession. This, once again, was the policy of Hoover and the Congress that passed Smoot-Hawley.

Only the Federal Reserve has behaved in a way to win the confidence of nervous investors. Usually the Fed is the most conservative arm of the federal government; its open-handed policy on the money supply since Oct. 19 suggests the seriousness with which the Fed views the economic situation.

The Fed was created to be the nation’s first line of defense in a market panic. When securities dealers were stretched to the breaking point by the collapse of stock prices, the Fed stepped in with easy credit--lots of it--for banks to make new funds available on Wall Street. This assistance helped stop the decline in market prices and restored order to the troubled exchanges. Since then the Fed has made clear that it is resolved not to repeat the errors of the months and years after 1929.

The Fed will attempt to stave off a recession by keeping interest rates low. The trouble is that the Fed may no longer be master in its own house. As much as it wants to keep interest rates down, markets may not cooperate. Too much money pumped into the economy could send interest rates higher because investors will fear inflation.

There are limits to what the Fed can do by itself--and limits to how long this country can drift in the absence of effective leadership.

We need a Congress and a President who can do their parts in these uncertain times. It is not enough for them to quibble over a few billion dollars in the federal budget; they must come to terms with the whole range of problems effecting the sluggishness and vulnerability of the world economy and declining U.S. competitiveness. Once the leadership deficit has been brought under control and Washington is once again capable of bold and constructive economic action, the markets will stabilize and the economy can grow. Then, who knows, we may even be able to get the budget and trade deficits down to reasonable levels.