If Gamble Pays Off, the U.S. Could Win Big

Stocks dropped sharply and bonds rallied but retreated Tuesday, offering mixed predictions for the economy under President Clinton’s Perot-like program to raise taxes and cut the federal deficit.

Clinton’s program, outlined in his speech Monday night, is basically a gamble that the recovering economy will be able to at least partly dispense with its dependence on deficit spending. If he wins that gamble, the U.S. economy could emerge very strong indeed over the next four years.

But if Clinton loses, rising unemployment and renewed recession could strike as early as this summer. Fears over the high stakes involved are what caused turmoil in the markets Tuesday.

The prospect of lower long-term interest rates indicates lower mortgage rates ahead. But other than that, there are few favors for consumers in Clinton’s program as revealed so far--with details to come in today’s State of the Union message.

All signs point to less disposable income, which means lower sales of cars and clothes and appliances.

That’s why stocks of auto and retailing companies led a rout of prices on all markets--the Dow Jones industrial average fell 82.94 points.

Yet Clinton’s plan is also emphatically non-inflationary. That’s why bond interest rates moved to 16-year lows Tuesday morning, with 30-year government bonds at 7.07% and 10-year bonds at 6.25%. The rates later retreated to a still-low 7.14% and 6.33%.

Clinton is counting on low interest rates to stimulate business borrowing and investment. So initially, events seem to follow his plan.

But behind the bond market’s cheer and the stock market’s raspberry, reactions were not as simple or logical. Some denounced the new President even while concluding that he is irrelevant to a strengthening economy.

“I think Clinton is basically slimy and dishonest,” one frustrated investment manager said, “but he’s not competent enough to derail this recovery.”

A Wall Street economist called Clinton “anti-business” for his attacks on pharmaceutical prices and executive salaries. But many business people conceded that “he’s doing what he has to do on the deficit.”

And the bond market’s cheer was mixed with calculation.

“Long-term rates have fallen, but are we betting they will stay down at 7%? Not on your life,” said a pension fund investment manager. “We don’t think it’s advisable to invest long-term right now.”

The danger in Clinton’s package is that tax increases--which the White House conceded Tuesday will fall on all taxpayers earning more than $30,000 a year--will drag the economy back into recession before any stimulus from government or private investment can take effect.

The ironic problem is that the $300-billion-plus federal deficit, even as it retards economic growth and keeps long-term interest rates high, also acts as a short-term crutch for the economy as U.S. industry restructures for global markets and the information age.

The burden of corporate layoffs and job eliminations would be greater if the deficit were not making Medicare and welfare payments and allowing defense work to continue at moderately high levels, explained economist David Levy of the Levy Economic Institute in New York.

Yet Clinton is saying: “Throw away the crutch.” The tax increases he’s proposing would expand government revenue by more than $100 billion over the next four years and go far to meeting his target of reducing the deficit by $145 billion.

As outlined by the White House on Tuesday, expectations are that couples with incomes above $180,000 will pay a 36% top rate of tax, instead of 31% now. Some higher taxes would be levied on incomes all the way down to $30,000 annually.

Clinton has also pledged to take more out of the defense budget than the Bush Administration had scheduled, which threatens further job cuts in the aerospace industry.

The President’s speech Monday gave few details of the incentives he will propose as “special efforts for displaced defense workers” or to create jobs and aid education and training.

The emphasis so far has been on the pain, not the gain.

And that frightened stock investors, who focused on the economy’s gloomier scenario: If the threat of higher taxes chills consumer spending, which has been rising in recent months, the economy could slow again by summer.

Unemployment would rise, and there would be pressure in Congress for an emergency spending program to stave off renewed recession.

Interest rates would shoot up and the markets would lose hope that the U.S. deficit problem will ever be solved.

But a sunnier outlook is also possible: If the recovering economy can withstand Clinton’s relative austerity program and there is real progress on reducing the deficit in the next few years, long-term interest rates would fall below 7%. The U.S. economy, combining efficient restructured industry with declining national debt, would be a powerful world engine.

Clearly, the optimistic scenario is guiding Clinton in his gamble. If his luck holds, there could be many winners.