ith 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.
