A Fiscal Train Wreck
By PAUL KRUGMAN
Columnist
The New York Times
March 11, 2003
With war looming, it's time to be prepared. So last week
I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm
terrified about what will happen to interest rates once financial markets wake
up to the implications of skyrocketing budget deficits.
From a fiscal point of view the impending war is a lose-lose proposition.
If it goes badly, the resulting mess will be a disaster for the budget. If it goes
well, administration officials have made it clear that they will use any
bump in the polls to ram through more big tax cuts, which will also be a
disaster for the budget. Either way, the tide of red ink will keep on rising.
Last week the Congressional Budget Office marked down its estimates yet again.
Just two years ago, you may remember, the C.B.O. was projecting
a 10-year surplus of $5.6 trillion. Now it projects a 10-year deficit of $1.8 trillion.
And that's way too optimistic. The Congressional Budget Office
operates under ground rules that force it to wear rose-colored lenses. If you take into
account - as the C.B.O. cannot - the effects of likely changes in the
alternative minimum tax, include realistic estimates of future spending and
allow for the cost of war and reconstruction, it's clear that the 10-year deficit
will be at least $3 trillion.
So what? Two years ago the administration promised
to run large surpluses. A year ago it said the deficit was only temporary.
Now it says deficits don't matter. But we're looking at a fiscal crisis
that will drive interest rates sky-high.
A leading economist recently summed up one reason why:
"When the government reduces saving by running a budget deficit, the interest rate
rises." Yes, that's from a textbook by the chief administration economist, Gregory Mankiw.
But what's really scary - what makes a fixed-rate mortgage seem like such a
good idea - is the looming threat to the federal government's solvency.
That may sound alarmist: right now the deficit, while huge in absolute terms,
is only 2 - make that 3, O.K., maybe 4 - percent of G.D.P. But that
misses the point. "Think of the federal government as a gigantic
insurance company (with a sideline business in national defense and homeland
security), which does its accounting on a cash basis, only counting premiums
and payouts as they go in and out the door. An insurance company
with cash accounting . . . is an accident waiting to happen."
So says the Treasury under secretary Peter Fisher; his point is that because of the
future liabilities of Social Security and Medicare, the true budget picture
is much worse than the conventional deficit numbers suggest.
Of course, Mr. Fisher isn't allowed to draw the obvious implication:
that his boss's push for big permanent tax cuts is completely crazy.
But the conclusion is inescapable. Without the Bush tax cuts,
it would have been difficult to cope with the fiscal implications of an aging population.
With those tax cuts, the task is simply impossible.
The accident - the fiscal train wreck - is already under way.
How will the train wreck play itself out? Maybe a future administration
will use butterfly ballots to disenfranchise retirees, making it possible to
slash Social Security and Medicare. Or maybe a repentant
Rush Limbaugh will lead the drive to raise taxes on the rich.
But my prediction is that politicians will eventually be tempted to resolve
the crisis the way irresponsible governments usually do: by printing money,
both to pay current bills and to inflate away debt.
And as that temptation becomes obvious, interest rates will soar.
It won't happen right away. With the economy stalling and the stock market
plunging, short-term rates are probably headed down, not up,
in the next few months, and mortgage rates may not have hit bottom yet. But unless
we slide into Japanese-style deflation, there are much higher interest rates in our future.
I think that the main thing keeping long-term interest rates low right
now is cognitive dissonance. Even though the business community is starting
to get scared - the ultra-establishment Committee for Economic Development
now warns that "a fiscal crisis threatens our future standard of
living" - investors still can't believe that the leaders of the United States
are acting like the rulers of a banana republic. But I've done the math,
and reached my own conclusions - and I've locked in my rate.
Copyright 2003 The New York Times Company |
