Deficits matter. That is one of the unmistakable lessons of the past year. Market-makers, who put their own money and livelihoods on the line, have indicated that the prospect of continuing deficits at high levels is a major factor in the persistence of high interest rates and the decline in stock and bond prices. An obvious conclusion is that interest rates might fall, with an accompanying improvement in investment and economic growth, if markets could be convinced that future federal deficits could be eliminated.
This is a conclusion that has been forced upon the president—thus his plan for additional budget cuts. These cuts are needed as part of any incremental movement toward a balanced budget. What remains to be seen is whether they will be convincing. My guess is that they won't be, which is why a balanced budget amendment to the Constitution is needed.
An amendment would be a more convincing step toward eliminating future deficits than would any amount of spending curtailment in the coming fiscal year. The Constitution is the fundamental law of the land. It endures from one election to the next; its mandates are not easily set aside. The Constitution is credible. It establishes rules that bind the next administration and the next Congress as well as those currently in office.
Because a constitutional amendment mandating a balanced budget would be a more credible signal that the federal government would maintain spending discipline, it would also be less politically costly. It is no coincidence that politicians tend to drift into noble rhetoric about making "hard choices" when the task at hand involves spending cuts. They know instinctively what most economists and opinion leaders have been reluctant to face: that the power to "control spending" involves little real "control." It is a power to accelerate but not to stop. The federal budget is like an 18-wheel truck with a feather-touch accelerator and no brake. Those at the wheel have very limited choices. They can swerve to one side to avoid hitting one group, but then they flatten another. They have no real power to stop the thing.
No analogy can be pushed too far, but there's a basic truth in this one. Not just American politicians, but all politicians, have failed in the effort to curtail runaway spending through ordinary political processes. The record on the point is clear.
Even some Republican leaders are indicating their belief that the economic recovery program, as now constituted, will fail. As successful politicians, they have their ears cocked. They have heard the gathering complaints of their constituents over high interest rates and budget cuts. What these senators and congressmen know is that individual voters tend to vote against incumbents when their incomes fall, no matter what the reason. Economic reforms that take three years to work may bear fruit too late to influence the next election. But an economic recovery predicated upon private investment is necessarily one that will take some time in the making.
In fact, high interest rates have reduced incentives to invest. Other things being equal, a business that yields a revenue of $100,000 with 20 percent interest rates is worth just half what it would be at interest rates of 10 percent. In a sense, high interest rates amount to a levy on capital. This isn't merely a matter of theory. Investors lost almost $200 billion in the decline in value of publicly traded companies between August and October.
The very real losses suffered by investors as a consequence of high interest rates show that budget deficits do matter in the market, even if they don't matter to some economists, including those in the councils of the current administration. Those who argue that the deficits are not inflationary are only right so long as the Federal Reserve doesn't "monetize" the debt, printing money to cover its overdue bills. If it doesn't, its only alternative is to borrow. Unhappily, the American economy does not generate enough savings to meet the resulting demands for credit—except at high interest rates.
Those rates are higher than they might otherwise be because there is a widespread expectation that future federal deficits will be so great that they cannot, politically, be accommodated with a tight money policy. Most people fully expect that before long the printing presses will be turned back on, sending the economy swirling along on the inflationary spiral at a still higher level.
There is a way out of this unhappy dilemma—enactment of a constitutional amendment outlawing deficit spending. Quick congressional action to enact a balanced budget amendment would not necessarily require that the deficit be eliminated any earlier than is now planned—by 1984. Allowing for a phase-in provision and the several years it would take to have the amendment ratified, the first year without deficits might be 1985 or even later. But the beneficial effects would be felt immediately.
Capital markets are efficient. They would no doubt act immediately to discount the prospect of lower inflation and reduced federal borrowing requirements. That is to say, investors would move to lock in high yields on government bonds. Interest rates would fall. This would lower the costs for private borrowers, at the same time increasing incentives to invest.
It would also make future budgets easier to balance by reducing the carrying charges on the national debt. Even a one-percent decline in average interest rates implies a savings of $10 billion annually on a debt of $1 trillion.
In short, deficits do matter. By eliminating them in the only way they can credibly be eliminated, through constitutional action, we can pave the way for true monetary reform and an end to inflation, which must be part of any lasting American economic renaissance.
Jim Davidson is founder and chairman of the National Taxpayers Union and author of The Squeeze.