Time Bomb Ticks Beneath the Economy

The Congressional Budget Office reported this week that the federal budget is completely out of control. Even if spending doesn’t grow as a share of the national economy, the green eyeshades at the budget office forecast $400-billion deficits as far as the eye can see.

The last time the budget was nearly this far out of whack, the country got up in arms. In 1992, Bill Clinton used the runaway budget to beat up the elder George Bush. Once elected, Clinton had to shelve most of his “public investment” agenda to reduce what was then a $29-billion-a-year deficit and calm Wall Street’s jitters. In 1995, Newt Gingrich threatened to push through a balanced budget amendment until Clinton agreed to cut spending even more. By this time, there was a consensus in both parties that deficit spending had to be reined in. By 1997, as the economy recovered, the deficit disappeared.

Now we’re in worse shape than in 1992, but the deficit doesn’t seem to arouse more than a giant yawn. What gives?

Democrats won’t lead the charge. That’s because they’re in a bind. If they criticize Bush on the massive deficits, they have to have a plan for reducing them. But how? If they demand repeal of the Bush tax cuts, Republicans will blast them for wanting to raise taxes. If they call for spending cuts, they will have to come up with some big-ticket items to cut. Yet they don’t want to appear soft on national defense, they back a Medicare drug benefit, and they want more spending on education and health care.

Besides, Democrats would rather attack Bush for his dismal record on jobs. They don’t want to blur their economic message with a lot of breast-beating about deficits. The public cares more about jobs than deficits any day. And on this score, the Dems have plenty of ammunition -- more than a million jobs lost since the recession officially ended in November 2001, and jobs are still hemorrhaging.

Bottom line: Democrats will grumble about Bush’s “fiscal irresponsibility,” but they won’t make it a big deal.

Don’t expect congressional Republicans to sound the alarm either, especially in the year before an election. They know the runaway budget is largely the Republican president’s fault, and party loyalty runs thick. Even the Congressional Budget Office (headed by a former Bush White House staffer) says that if Bush gets everything he wants -- extensions of his tax cuts, a Medicare drug benefit and money to rebuild Iraq and stabilize Afghanistan -- the budget deficit goes into the stratosphere.

Anyway, if the runaway budget isn’t Bush’s fault, then it must be Congress’ fault. And who’s in charge of Congress? Republicans. That’s the inconvenient thing about running all branches of government. You can’t blame the other guys.

Republicans also learned an important lesson in the last budget crisis. The best way to fulfill their dream of a tiny government in Washington is to starve it. Make the deficit grow so big that in a few years Democrats will have no choice but to go along with massive spending cuts -- slashing even sacred cows like Social Security and Medicare. The strategy worked before. The giant deficits that the first Bush ran up made it impossible for Clinton to do much of anything.

If neither party will make a big deal out of the runaway budget deficits, the American public won’t much care. Here’s another lesson from the ‘90s: Americans don’t like the idea of gigantic budget deficits when they symbolize a government that’s out of control. But large deficits in themselves don’t bother most people. Who can possibly grasp the meaning of $1.4 trillion (the CBO’s 10-year deficit forecast)? The public is worried about jobs, paychecks and terrorism. Budget deficits are abstractions.

Where’s Wall Street in all this? In the early ‘90s, you may remember, bond traders were howling about out-of-control budget deficits because the government’s voracious need to borrow was crowding out private investment. Not this time, at least not yet. The economy still is so flaccid that not even $400-billion deficits are putting a crimp in corporate borrowing. Most businesses have no interest in investing until there’s enough demand for their products and services to warrant it. In fact, big federal deficits are needed right now to stimulate demand and get the economy back on track.

So what’s the problem with Bush’s deficits? The crunch will come a few years from now, once the economy is back on track. Then, the projected deficits will create havoc because they will use up scarce capital. The Medicare drug benefit that Bush wants is likely to balloon as boomers retire. Huge military outlays, combined with the billions needed for rebuilding Iraq and ensuring homeland security, will continue because the war against terrorism is likely to go on and on. And if Bush gets his way and makes permanent his temporary tax breaks, the budget gap will only get worse.

This means interest rates will go sky-high. They may already be heading that way. Wall Street is just beginning to feel nervous about the projected deficits. Mortgage rates are moving upward in many parts of the country. It stands to reason. Who wants to lend money at 6% for 15 years when there’s a good chance of a capital squeeze in a few years that pushes long-term rates north of 10%?

Higher long-term rates can stall the recovery and hurt Bush’s chance of being reelected. In other words, if Bush chokes on the projected red ink, it won’t be because of Democrats or Republicans. It will be because Wall Street starts to worry about the future.