Clintonomics Undone : The ‘Investment’ Candidate Proves a Deficit Hawk

It was chilled and overcast as the borrowed corporate jet, inbound from Washington, sliced through the cloud cover into the Little Rock, Ark., airport early on the morning of Jan. 7, 1993.

Robert Rubin, a wealthy Wall Street financier and one of President-elect Bill Clinton’s closest confidants, had arranged for the plane so they could all fly down together: Rubin, Lloyd Bentsen, Leon Panetta, Ira Magaziner, Roger Altman, Alice Rivlin and perhaps half a dozen others. Tumbling onto the Tarmac came most of the Clinton brain trust, an eclectic group of millionaires, academics, consultants and career politicians, men and women with almost nothing in common save their ambition to serve in the first Democratic Administration in 12 years.

Rubin saw his main task as the “honest broker,” the coach who would make sure everyone felt part of a team. And it was arguably the most important team in the country--the economic policy players of a new President who had just won the White House at the end of the longest economic slowdown since World War II, a President elected on a promise of jobs, growth and fundamental economic change.

Yet already, petty feuds and policy differences had turned erstwhile allies into rivals. Magaziner and Bob Reich, for example, had co-authored a book and worked side by side through the long ordeal of 1992. Now, before Clinton could even take the oath of office, they had engaged in a bloody battle for position in the new Administration. Their camaraderie had soured into mutual contempt.

Others--Bentsen and Panetta among them--were newcomers brought in during the presidential transition to add credibility or diversity to the new government. Yet they cared little what Clinton might have said on the stump in Atlanta or Los Angeles the previous autumn. Indeed, Panetta, one of the leading deficit hawks in Congress, publicly criticized Clinton’s economic program in the midst of the campaign while privately warning Clinton that the numbers behind his campaign’s economic plan didn’t square. Rivlin, regarded as the most knowledgeable budget analyst on the team, was already irritating campaign veterans with her single-minded focus on the deficit.

Still, Clinton needed--and wanted--these newcomers. They gave him gravitas and spelled stability to Wall Street, which was still skittish over the recent transfer of power in Washington. The bond market in particular was worried that Clinton would inflate the deficit with his promised new spending programs.

So, in his key appointments on economic policy--the heart and soul of the new Administration--Clinton was turning to America’s financial and political elites, just as John F. Kennedy, his role model, had done more than 30 years before. In Rubin, for example, Clinton would have his own Douglas Dillon, the Republican Treasury secretary whom Kennedy recruited from Wall Street.

By early January, a quiet coup was in progress. With Clinton’s approval, the newcomers were taking charge, gradually distancing the President-elect from the rhetoric and ideas of his campaign. And by the time Clinton settled into the White House, a stunning transformation would occur.

A buoyant campaign agenda emphasizing expanded federal “investment” in infrastructure, technology and people would become a dour prescription stressing deficit reduction above all else. A promised tax cut for middle Americans would be jettisoned in favor of tax hikes hitting squarely at the suburban classes.

To a considerable degree, the first liberal Democratic President in 12 years would be leaving the fate of his presidency in the hands of Wall Street’s most conservative and skittish creatures: bond traders.

That was fine for the White House in 1993, when rates were steadily declining. But by February, 1994, when the Federal Reserve Board began raising rates and the stock market fell off the cliff, Clinton would find himself strapped into a deficit-reduction straitjacket. And, like George Bush before him, he could do little but watch from the sidelines as economic policy moved against him.

Still, in early 1993, all that was in the future.

That January, almost as if by some mysterious alchemy, Bill Clinton was changing into a completely different--and far more conservative, tradition-bound--politician than the one who had been elected the previous November.

Over time, the new President and his defenders would acknowledge the sea change in his economic plan. But they would publicly blame it on circumstances beyond their control. They would insist that the federal deficit turned out to be even bigger and more frightening than anyone had imagined; they argued that officials in the Bush White House had hidden the extent of the problem until the last days before Clinton’s inauguration. And when Clinton and his team realized just how bad the deficit really was, they were forced to rethink their priorities.

But extensive interviews with top Administration officials, including virtually all of the President’s key economic advisers, reveal that this rationalization was largely disingenuous.

For months before the election, Clinton and his closest aides knew that the budget numbers in his campaign agenda didn’t add up and that candidate Clinton had promised far more than he would be able to deliver. They also knew by the summer of 1992 that the deficit was much worse than was assumed in their campaign documents. But they refused to change the obsolete arithmetic on which Clinton’s campaign economic plan was based, for fear of attracting negative press coverage and attacks from the Bush campaign.

What’s more, Clinton’s closest confidants also recognized that in his heart of hearts, Clinton was much more of a deficit hawk than the media or the American electorate ever would have guessed.

So a sharp reversal from Clinton’s campaign agenda was inevitable all along. Indeed, senior Administration officials, including Bentsen and Panetta, concede that the professed shock at higher deficit estimates issued after the election was largely feigned. Moreover, the new Clinton team issued initial budget projections soon after taking office that put absolutely the worst face possible on the deficit outlook, manipulating data to reinforce the impression that Bush had left Clinton with a fiscal nightmare.

The expressions of outrage were designed in part to provide political cover for the policy coup that was already well under way.

At 10 a.m. on Jan. 7, as movers down the hall packed up the President-elect’s belongings, Rubin and his entourage filed into the dining room of the Arkansas governor’s mansion. They sat down around the long dining table for a meeting with Clinton and Vice President-elect Al Gore. The session continued until 5 p.m.

It was the first meeting of Rubin’s National Economic Council, a new Cabinet-level organization that would come to hold sway over most domestic and international issues requiring presidential attention.

In hindsight, many of the participants now concur, that marathon meeting and a lengthy follow-up session a week later were two of the most critical events of the first year of the Clinton presidency. During those sessions, Clinton took the final step away from his campaign’s economic agenda.

Out of five deficit-reduction paths presented as options during the Jan. 7 meeting, Clinton chose the most aggressive. It called for cutting the deficit to roughly $205 billion by fiscal 1997, the final year of his first term. That meant slicing $140 billion from that year’s projected shortfall as part of a multiyear deficit reduction package that would lock Clinton into set levels of spending throughout that term.

As every budget analyst knew--and as many told Clinton the previous year--the only way to make a dent in the deficit would be to take money from the middle class, something he had sworn not to do during the campaign. So Clinton’s $60-billion tax cut for the middle class would finally have to be killed.

In its place, the Clinton team would propose a startling substitute: a $71.5-billion energy tax that would land squarely on middle-class Americans. There would be other unpopular revenue items: a $29-billion proposal to tax Social Security benefits received by more affluent retirees and a Reaganesque plan to freeze cost-of-living adjustments for Social Security benefits and other entitlement programs.

Meanwhile, Clinton’s investment agenda would be scaled back, leaving some aides bitterly disappointed. During the campaign, Magaziner pushed for $50 billion a year in new “investment spending.” Instead of these more ambitious plans, Clinton would propose a $16-billion short-term stimulus plan, along with a five-year investment program starting at roughly $20 billion a year. Most analysts agreed that the economic effects would be so small that they would be drowned out by the new wave of deficit reduction.

With its reliance on higher taxes to cut the deficit, Clintonomics was beginning to look a lot like Bushonomics.

Alan Blinder was surprised just to be in the dining room with the rest of the Rubin group. A shy yet highly regarded Princeton economist who often commuted across campus by bicycle, he had been an occasional adviser to the Clinton campaign. But as the calls from Little Rock became less frequent in the fall of 1992, he felt certain he would be passed over for a top-level Administration job.

He was right. Clinton turned to Blinder’s old friend and former classmate, Berkeley economist Laura D’Andrea Tyson, to become the first woman to chair the White House Council of Economic Advisers. But Tyson, aware of her lack of experience in macroeconomic forecasting and analysis, asked Blinder to come and work with her. Blinder buried what few feelings of resentment he felt and became Tyson’s No. 2 on the council.

So it fell to Blinder, perhaps the least political person present during the January sessions, to underscore for Clinton the potential impact--and political risks--of his new focus on deficit reduction. While campaign consultants Paul Begala and James Carville worried openly about the immediate political effect of broken promises, Blinder and Tyson feared the new strategy could threaten the fragile recovery, making it more difficult for Clinton to generate new jobs.

“The worst-case scenario of the policies we’re now considering,” Blinder told the President-elect, “is a George Bush-style recession.”

It was a clear enough warning for a politician who had just beaten Bush with a campaign rallying cry of “It’s the economy, stupid.” Recalls Blinder matter-of-factly: “I think my statement caught his attention.”

With his new agenda, Blinder warned Clinton, the only hope for economic growth would come from a potential beneficial impact on long-term interest rates. As the deficit fell under Clinton’s plan, the government’s borrowing demands should fall as well. So should long-term interest rates. Indeed, “long rates” had remained stubbornly high despite record-low short-term interest rates; economists called the phenomenon a “steep yield curve,” reflecting the fact that many financiers weren’t convinced that inflation was really whipped.

If the financial markets became convinced that federal borrowing demands would be permanently reduced, the yield curve could flatten. Interest rates on many loans and mortgages would subside, motivating consumers to buy more houses and cars. Rates on bonds would drop, prompting companies to borrow funds to invest in new plants and hire more workers. Under this scenario, a reduction in federal spending could, ironically, cause an expansion in the overall economy.

Rubin and Altman, both fresh from Wall Street, were convinced that the markets were ripe for just such a chain of events. They persuaded Clinton to embrace their argument that aggressive deficit reduction would lead to faster economic growth. But academics Tyson and Blinder cautioned that this was all untested theory. Clinton would be counting on lower interest rates to accelerate the economy before the reduction in federal spending could slow things down. No administration had ever accomplished anything quite like it.

Blinder and Tyson agreed with Rubin and Altman that deficit reduction would be the proper long-term policy. But they didn’t want Clinton to be sold on the idea that it could guarantee quick economic growth.

The evidence was spotty on whether the Rubin-Altman formula would benefit a President facing a four-year election cycle. True, the economic drag should prove temporary, while the benefits would be permanent and ultimately much larger. Over 20 years, Blinder said, the deficit reduction program could increase annual economic growth by 1.1% to 2.2% per year. But the costs were likely to outweigh the benefits for at least five years.

Frustrated, Clinton wanted better answers, better forecasts. Tyson said accurate economic models for measuring the effects of deficit reduction on interest rates didn’t exist. Blinder warned Clinton that if he embarked on a regimen of stiff deficit reduction and budget restraint, he could be held hostage to the whims of the financial markets--and the Federal Reserve Board.

Clinton had already met with Fed Chairman Alan Greenspan, but he had received no assurances of accommodation. Altman had met privately with some Fed officials who indicated they thought the size of the deficit package Clinton was considering was appropriate. There were no promises of additional interest rate reductions, though; the Fed had lowered short-term rates by four percentage points since the beginning of the Bush recession in mid-1990, and the central bank’s inflation hawks feared any further cuts could prove combustible.

So Clinton’s multiyear deficit reduction plan would limit his flexibility on economic policy, Blinder warned, potentially placing the fate of his presidency in Greenspan’s hands. The same fate had befallen Bush after he agreed to a 1990 deficit-reduction pact in which he too had broken a key campaign promise on taxes.

“We really should get some kind of understanding with the Federal Reserve,” Blinder told the President-elect.

When Greenspan sat next to First Lady Hillary Rodham Clinton during her husband’s State of the Union address in February, many Fed watchers suspected that he had reached just such a detente with the President. The central bank’s passivity for the remainder of the year also led observers to believe that Greenspan tacitly endorsed Clinton’s deficit-reduction plan.

But that perception was shattered at the start of Clinton’s second year in office.

Last Feb. 4, the Fed raised interest rates for the first time in five years; it raised them again on March 22--and again last Monday. Now, with analysts predicting the Fed will continue to boost short-term rates steadily throughout the year, Clinton can only hope to influence it by putting some of his people on the central bank’s seven-member board of governors.

On Friday, the President made his move. His nominees: UC Berkeley’s Janet Yellen, regarded as more concerned with unemployment than inflation, and Alan Blinder. If confirmed as Fed vice chairman, Blinder will become the odds-on favorite to succeed Greenspan when the chairman’s term expires in March, 1996.

Betting the House on Bonds

In his election campaign, Bill Clinton talked about major investments in job creation and training, infrastructure and technology--a platform that frightened the financial markets but won him the presidency. Once in office, Clinton set out to win the confidence of the bond market, in particular, committing his government to lowering the federal budget deficit. The theory: Less federal spending and borrowing would lead to lower long-term interest rates, buoying consumer spending and business investment. It worked--only too well, in the eyes of the Federal Reserve Board. Yields on 30-year Treasury bonds and rates on 30-year mortgages fell steadily until the robust recovery began making bond investors and the Fed nervous. The question now is if Clinton’s theory--and the economy--will unravel as the Fed tightens credit.

Yield on 30-year Treasury bond:

July 16, 1992: Arkansas Gov. Bill Clinton wins Democratic presidential nomination

Nov. 3, 1992: Clinton defeats George Bush and Ross Perot in presidential election

Jan. 20, 1993: Clinton inaugurated

Aug. 6, 1993: Congress narrowly approves sweeping Clinton program of tax increases and spending cuts

Oct. 15, 1993: Government reports consumer prices rising at just 2.5% annual rate

Jan. 28, 1994: Government reports economy grew at torrid 5.9% rate in fourth quarter of 1993

Feb. 4, 1994: Federal Reserve boosts short-term interest rates for first time in five years, raising federal funds rate from 3% to 3.25%

March 22, 1994: Fed boosts funds rate to 3.5%

April 18, 1994: Fed boosts funds rate to 3.75%

Mortgage Boomerang

Average rates for 30-year home mortgages have tracked the swings in the market for long-term bonds.

July ‘92: 8.04%

Nov. ‘92: 7.82%

April ‘93: 7.29%

Oct. ‘93: 6.76%

Last week: 8.49%

“There are many people who believe that the only way we can get this country turned around is to tax the middle class more. . .My plan is a departure from trickle-down economics . . . I propose an American version of what works in other countries--I think we can do it better: invest and grow.”

Arkansas Gov. Bill Clinton, third presidential debate, Oct. 19, 1992.

“But in the end, we have to get back to the deficit. For years there’s been a lot of talk about it, but very few credible efforts to deal with it. And now I understand why, having dealt with the real numbers for four weeks.”

President Bill Clinton, State of the Union Address, Feb. 17, 1993

Note: Final weekly figures, except most recent