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A Fiscal Train
Wreck
By Paul Krugman, NYT,
031103
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.
http://www.nytimes.com/2003/03/11/opinion/11KRUG.html
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