Sixty years ago, the combination of a misunderstood financial crisis, a breakdown in world trade, tax increases and erosion in business and consumer confidence shut down the economy as every “sound” step taken by the government failed.
Today it is all too easy to see a parallel. Legislation that was supposed to solve the savings-and-loan crisis worsened it and spread malaise into the commercial-banking system. The General Agreement on Tariffs and Trade talks ended unsuccessfully as countries chose protection over competition. Tax hikes and increasing regulations are reducing the return on investment. And confidence-shattering deficits are about to appear.
Indeed, if deficits matter, we are going to be in big trouble. This fiscal year, the federal deficit is expected to hit $320 billion, and that’s before the cost of our Persian Gulf deployment and the weakening economy are factored in. It wouldn’t take much bad luck, together with the current bad policy, to produce a $400-billion deficit.
That’s almost twice Ronald Reagan’s biggest deficit and represents a huge increase over the $152 billion in 1989. Moreover, a recession may wipe out the $50 billion state and local government budget surplus, which reduced the impact of the federal deficit during the 1980s.
Such an enormous jump in the deficit, after a decade of hysteria over debt, may be the straw that breaks the back of business confidence. If the economy does worry about the deficit, as federal Budget Director Richard Darman claims, then his decision to make the deficit 10 feet tall by including the gross cost of the S&L; bailout was a strategic error.
Darman’s tax increase was a similar error. By helping to weaken the economy, the tax increase fertilized the red ink. Psychologically, it has convinced many that the U.S. deficit is so intractable that not even a tax increase can help.
Downward pressure on the dollar will mount as investors look for more promising national economies. If the government mishandles a “dollar crisis” as badly as it did the “deficit crisis,” it will bring down the international monetary system.
Two years of the Bush Administration have proved that George Bush believes that it is more important to “make government work” than to make the economy work. Consequently, we have had a burst of costly and destructive regulation that is dramatically raising the cost to business while destroying the value of assets.
Naive regulators believed that last year’s S&L; legislation would recapitalize the thrifts. Instead, the new law further decapitalized the the S&Ls; and contributed declining home values to the factors eroding consumer confidence. The tighter the regulatory screws turn, the more S&L; assets pile up in the government’s hands and the fewer the buyers who want to enter a business where regulation is reducing the profitability. L. William Seidman, chairman of the Resolution Trust Corp., now says that there is a “conflict between regulating these institutions and trying to dispose of the assets at the RTC.”
Bank capital, once the basis of depositor confidence, lost its historic role to federally insured deposit insurance and declined from 15% of deposits to 5%. Now, all of a sudden, regulators want bank capital to equal 8% of assets by 1992. The only way most banks can achieve this is by curtailing their loans--hardly a helpful move as credit dries up in an economic downturn.
Other regulatory initiatives, together with criminal prosecutions, have destroyed the liquidity that the high-yield bond market created in the 1980s for companies that lacked investment-grade credit ratings. With banks forced to cut back on loans, many companies now have literally no source of funding.
The Clean Air Act, historic federal legislation for the handicapped, the Superfund and the continuing prospect of a job-quota law are reducing the profitability of U.S. investment. If the long Reagan boom did not produce enough investment, as critics claim, to keep America competitive, the high-cost regulatory economy of the 1990s can only worsen our relative position.
The 1980s were years when policy-makers and pundits needed to build the nation’s confidence to carry us through the financial restructurings necessitated by disinflation. Instead, people were encouraged to leverage their debts as protection against “inflationary deficits,” thus making the debt bubble larger. Once it appeared, regulators made certain it would pop with the loudest possible noise. The combination of 20 million new jobs along with disinflation was a historic achievement and a rare opportunity to cure inflation without a bust. Too bad politicians threw it away.