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Current Affairs

Crossing to Surplus

Just finished reading Robert Rubin’s “In an Uncertain World” last night. Read it cover to cover in one sitting — it’s that interesting. Lots of stuff about his years in the Clinton administration both before and after his appointment as Secretary of the Treasury.

But the most interesting material for me was the discussion of supply side vs. traditional economics. Rubin’s view is that the huge Federal budget deficits that had run up in the early 1990’s — and which have returned since the Bush tax cut coupled with the war and reckless Federal domestic spending — are the root of all evil.

These deficits predictably and eventually lead to artificial increases in interest rates — because that’s what’s required to get capital into this country to finance the deficits. He’s pessimistic — and can’t predict when — about our current course, knowing that there’s a price to be paid eventually and the clock is ticking as the dollars flow in from overseas (mostly from China and other Asian countries) to buy our treasury notes.

In his most recent report to Congress, Federal Reserve Chairman Alan Greenspan highlighted the same issue:

The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics–especially the retirement of the baby-boom generation beginning in just a few years–mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be.

The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the relatively near term. Long-term interest rates reflect not only the balance between the current demand for, and current supply of, credit, they also incorporate markets’ expectations of those balances in the future. As a consequence, should investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible as prospects for outsized federal demands on national saving become more apparent. Such a development could constrain investment and other interest-sensitive spending and thus undermine the private capital formation that is a key element in our economy’s growth prospects.

In other words, interest rates are not wholly within the control of the Federal Reserve. Instead, it’s a supply and demand market and those with the capital to invest dictate the price at which they’ll make the investment — on the basis of their belief in the country’s prospects for actually dealing with fiscal reality.