Economic Outlook for the United States Deficit

Guest columnist shares his carefully researched views on the current economic outlook for the United States deficit.
By Mark Rapp
November/December 1985
Add to My MSN

Surprisingly, after a decade of difficulties, setbacks, and double-digit inflation, the Federal Reserve seems to have adopted a policy capable of keeping inflation under control.
PHOTO: FOTOLIA/R-O-X-O-R


Content Tools

Related Content

The Population Problem

Our habitat won’t allow the human population to expand forever. But if the global population stabili...

The Road to Economic Recovery Will be a Slow One

It took a long time to get into this mess. It will take a while to get out of it.

Stop Spending Money: How Consumerism Takes Its Toll on Our Happiness

The Economics of Happiness, a documentary about the healthy potential of economic localization, reve...

Creative Uses for Wooden Pallets

Wood pallets can be used as is or stripped and remade into new forms. What creative uses have you fo...

Mark Rapp shares the economic outlook for the United States deficit.  

A few months back, Mr. Mark Rapp wrote to us and shared his insights into some of the information printed in the then current issue's Economic Outlook column. We were quite impressed, both with Mr. Rapp's careful research into the economic situation and with his ability to apply his own interpretive skills to that carefully gathered data in order to reach clear, incisive, and sometimes surprising conclusions. To make a long story short, we invited Mark to write a guest column for us, and we're pleased to present his first effort here. 

It seems to have become fashionable these days to regard economics as an imprecise and inexact science. We've been hearing a lot of this sort of talk from Washington lately (especially when some economic specialist comes up with something that's less than positive about the U.S. economy). Ironically, though, even some of the "established" economic experts are beginning to admit that forecasting is less accurate than it was a decade ago.

There are several reasons for the present quandary when trying to understand the economic outlook for the United States deficit. The predictions that most often make it into the news are "unconditional" forecasts, but economists can hardly be expected to foresee all the actions of our government, OPEC, foreign investors, the weather, or other outside influences. It is, of course, also dangerous to oversimplify a complex situation, but that's exactly the manner in which many predictions are presented to the public. The bottom line is that the effects of unpredictable factors have made economic forecasting extremely arduous.

However, everybody still wants predictions. Everyone wants to know, Is supply-side economics working? It would be difficult to answer that question, though, because the answer depends on a great number of factors. It would be better to make the question more specific and ask, for whom is it working? But again, we must be careful. A lot depends on the vocation or political orientation of the person in question—on whether he or she is someone helping to rebuild the "arsenal of democracy" or a midwestern farmer. Simple answers are hard to come by these days.

Surprisingly, after a decade of difficulties, setbacks, and double-digit inflation, the Federal Reserve seems to have adopted a policy capable of keeping inflation under control. While supply-siders are taking a lot of the credit for low inflation, I'm sure the mem bers of the Federal Reserve Board are breathing a heavy sigh of relief over currently declining oil prices. For now, it looks as if the Fed's generally tight monetary policy has eased the inflation rate down to an acceptable level. How long it will stay there remains to be seen. Present economic events could easily lead to renewed inflation, as we'll see in a moment.

While inflation could return to haunt us, the demon that presently poses the greatest menace to our economic well-being may prove even less visible and more devilish. Government economists politely call the demon the "budget deficit" and have, until recently, tried to downplay the threat that this deficit poses to our economic recovery. The deficit, now around $200 billion a year, is basically a result of government borrowing. Thanks to this borrowing, the federal deficit is eating up a large portion of the national credit pool.

Economic prophets have asserted since the recovery began that if nothing is done about the deficit, it will lead to an increase in interest rates. The scenario goes something like this: As the government borrows more money, and as our economic recovery causes business to improve to a point where business and consumers start borrowing more money, the competition for cash will force up interest rates. It's the old law of supply and demand: The higher interest rate is the price you pay for borrowing money that's in short supply but in high demand. These higher interest rates will stall out the recovery, as interest rates are already prohibitively high and, if anything, need to come down. A possible solution would be to have the Federal Reserve pump money into the economy to relieve the cash shortage. However, if the Fed starts creating lots of currency, we get inflation. So, the argument runs, we either have to cut the deficit, or face renewed inflation or recession.

But as the recovery strengthened, the inflation rate remained low, interest rates did not rise, and the deficit remained higher than ever. Again, the experts suffered denigration at the hands of Washington. However, most of these experts didn't get their degrees in economics by being inept. The day of reckoning for the recovery did finally come, but it was later than expected and had less of an effect than was feared.

In the first half of 1984, the strain between government borrowing to finance the deficit and private borrowing to finance the recovery began to assert itself in the form of rising interest rates. The experts gleefully watched as the prime rate climbed to 13% by midyear. For lack of any better ideas about how to avoid the blame for this consequence of the deficit, Washington pointed a finger at the Federal Reserve, which had restricted the growth of the money supply. And finally, the recovery began to stall as a result of climbing interest rates. The Fed responded to the threat of renewed recession by easing up on the money supply. This brought down interest rates, which stimulated the economy and got the recovery back on track.

You'd think the experts would have been happy after all this, but a few things were still troubling them. This whole recovery was much stronger than expected, and many questions still needed answers. Why hadn't interest rates gone up sooner and faster? Something was missing; there was an unexpected factor involved in the recovery. The missing piece of the puzzle and the reason for the strength of our recovery turned out to be foreign investment.

The U.S. is being flooded by a tidal wave of foreign money that even the president's own forecasters failed to anticipate. Pounds, pesos, francs, and yen have poured into America by the billions, doubling foreign investment in the past five years to an incredible $833.1 billion. Foreign purchases of U.S. debt securities have recently been running close to $100 billion a year, or about half the annual deficit. Even those who once took refuge in the belief that the national debt was nothing to worry about are getting nervous. It's beginning to look like we do not owe it all to ourselves.

Therefore, contrary to many predictions, instead of high interest rates climbing even higher, this inflow of money from abroad kept cash from becoming too sparse here. Foreign investors were drawn by our apparent economic health and were especially attracted to the higher rates of interest paid on U.S. Treasury securities. Essentially, our high interest rates became the magnet that drew foreign capital needed to finance the budget deficit and keep a lid on those same interest rates. We created an equilibrium of sorts, but it looks like we got hooked on what could be a fickle source of capital.

Even with all the foreign money pouring into the country last year, upward pressure on interest rates (caused by the deficit) outweighed foreign alleviation, and interest rates did go up. As already mentioned, the recovery began to stall, which is something that tends to make foreign investors very nervous. If the deficit remains high and the Fed tries to keep this recovery going by driving down interest rates with bigger and bigger doses of printed money, foreign funds may soon flee the country for fear of renewed inflation. The result could be a new recession or renewed inflation or both.

Foreign investors have come to fear a rebirth of U.S. inflation (or recession) almost as much as we do. The health of their pocketbooks depends on our continued economic health. Of course, their reaction to a re-emergence of economic ills here would be to get their money out of the U.S., which would only aggravate our problems. It seems pretty clear, then, that a lot now depends simply on foreign confidence in the U.S. economy.

And here we come to somewhat of an impasse. It is President Reagan's assertion, in accordance with supply-side theories, that the budget deficit can be reduced through a continued expansion of the economy. Many economists disagree with this. Even Federal Reserve Chairman Paul Volcker has said he doesn't see any possibility of simply growing out of the budget deficit. And this time the facts tend to support the experts. The U.S. economy has been growing and the deficit remains as large as ever. The administration is being forced into the position of trying to beat down an embarrassing deficit with spending cuts, lest our foreign benefactors get the idea that maybe supply-side economics really isn't working out so well.

The severity of the situation came into focus in February, when Volcker warned that if the federal budget deficit remains as large as it has been, foreign investors will lose faith in the U.S., causing them to reduce their partial financing of the national debt and launching us into a new recession.

So if the deficit threatens to cause another recession by driving up interest rates or driving off foreign investment, why all the hem-hawing around in Washington? Why don't we use tax hikes and spending cuts to balance the budget? Well, that would be nice, if only life were that simple. You see, it is precisely this unprecedented deficit spending which basically financed, and is still fueling, our economic "recovery"!


Previous | 1 | 2 | 3 | 4 | Next






Post a comment below.

 








Subscribe Today - Pay Now & Save 66% Off the Cover Price

First Name: *
Last Name: *
Address: *
City: *
State/Province: *
Zip/Postal Code:*
Country:
Email:*
(* indicates a required item)
Canadian subs: 1 year, (includes postage & GST). Foreign subs: 1 year, . U.S. funds.
Canadian Subscribers - Click Here
Non US and Canadian Subscribers - Click Here

Lighten the Strain on the Earth and Your Budget

MOTHER EARTH NEWS is the guide to living — as one reader stated — “with little money and abundant happiness.” Every issue is an invaluable guide to leading a more sustainable life, covering ideas from fighting rising energy costs and protecting the environment to avoiding unnecessary spending on processed food. You’ll find tips for slashing heating bills; growing fresh, natural produce at home; and more. MOTHER EARTH NEWS helps you cut costs without sacrificing modern luxuries.

At MOTHER EARTH NEWS, we are dedicated to conserving our planet’s natural resources while helping you conserve your financial resources. That’s why we want you to save money and trees by subscribing through our earth-friendly automatic renewal savings plan. By paying with a credit card, you save an additional $5 and get 6 issues of MOTHER EARTH NEWS for only $12.00 (USA only).

You may also use the Bill Me option and pay $17.00 for 6 issues.