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Failure to balance federal budget carries big risk

Surveys have shown that most people think that they could live very well if they just made 20 percent more than their current salary. It does not really make any difference whether that current salary is $20,000 or $100,000, 20 percent more seems to be everyone’s idea of nirvana. It also seems to be true that once that additional 20 percent is achieved, that the new target is 20 percent higher than that. What would the typical family do if it had easy access from a bank for that additional 20 percent of current salary each year in the form of a loan. What I mean by this is no fixed repayment schedule and no bank loan officer saying “no.” My guess is that a majority of people would go out and do that, and why not? The “why not” is that at some point even the friendly banker might start putting some terms on the loan. Realistically, you may have to pay some back before you borrowed any more, and maybe the interest rate would move up.
One of the most interesting debates in Congress this year is whether the U.S. government should continue spending 20 percent more than it takes in. This has resulted in current total debt of approximately $4.8 trillion, which is mostly financed by the issuance of Treasury bills and Treasury bonds. Because the market never seems to say “no” to securities backed by the full faith and credit of the U.S. government, there has not been a strong incentive to stop.
Coincidentally, politicians continue to spend money even after all of the taxes are exhausted–mostly on causes that either generate votes or campaign contributions or both. This is a great deal because the benefit of spending can be achieved now and the payback can occur on somebody else’s watch.
One of the key debates in Congress this year is centering on whether the budget deficit makes any difference. President Bill Clinton’s initial budget for this year called for a deficit in excess of $185 billion and continuing large deficits as far as the eye could see. He didn’t seem to think that this was a problem.
The Republicans countered with a balanced-budget amendment, which lost by one vote in the Senate and even if it passed, would have required a vote by the states before it became effective. Undaunted, the Republicans then developed a seven-year plan to balance the budget. Remember, even assuming the implementation of the Republicans’ plan, the total debt of the U.S. government at that time would be in the $5.5 trillion to $6 trillion range.
This means that even though we then would have a balanced budget on an annual basis, we still would have this tremendous overhang from the past that would result in approximately $300 billion of interest payments per year. This computation of interest on the already existing debt is built into all of the projections of reducing the deficit to zero and is the factor that makes it much more difficult to accomplish.
Given the apparent difficulty of reducing the deficit to zero, why would we want to do it? I propose the following three reasons:
1. Everybody seems to understand that if we borrow money eventually we have to pay it back. If the federal government uses 30-year Treasury bonds to fund the deficit in any given year, even that has to be paid back at the end of 30 years. Other bonds can be substituted at that time, but we really do not know under what terms that refinancing will occur. Interest rates could be much higher, and for unknown reasons the creditworthiness of the United States could be in question. The average person understands these issues intuitively and this is why a larger and larger percentage of people favor balancing the budget.
2. Large deficits each year cause the total amount of interest paid in future years to be an ever-greater percentage of the federal budget. So, the government is faced with the problem of either borrowing even more in order to make interest payments, or cutting useful and effective programs because too much of our budget is directed toward payment of interest. We are very close to this situation right now.
3. Excessive federal debt causes us to lose control of our destiny. The best example of this is that one of the key things that Alan Greenspan has to think about before he reduces interest rates is the impact on foreign lenders to the United States. Because foreigners control significant amounts of Treasury bills and bonds, the U.S. government has to make sure that interest rates are high enough to continue to attract them.
It may be perfectly prudent for the Federal Reserve Board to reduce interest rates in order to stimulate the U.S. economy and perhaps help it out of a recession, but in the future we may not be able to do that because our No. 1 priority may be continuing to satisfy those foreign entities that invest in Treasury bonds. If this line of reasoning is correct, then we may be on our way to losing one of the key controlling influences that the federal government has in reducing the severity of an economic recession.
Also, many economists believe that at least some of the severe problems that we have been having with the dollar are related to our inability to balance our budget and the uncertainty that this creates. If you think that a reasonably strong dollar is not necessary, then give me some historical examples of countries with a strong economy and a long-term weak currency.
In conclusion, we have some choices to make. Medicare is scheduled to run out of money in 2002 and Social Security follows suit shortly thereafter. As the TV ad said so succinctly, “You can pay me now or pay me later.” The choice that we make on this issue will have a dramatic effect on the long-term success of our economy.
(John Mooney is president of Essex Investment Group Inc., a diversified financial services firm and real estate developer.)


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