Getting Serious about the Economy

Despite the passage of President Reagan's tax-cut and spending-cut programs, interest rates remain stuck at the 20 percent level. As long as rates remain that high, companies will be unable to invest the vast sums needed to modernize their plants, creating new jobs and restoring American competitiveness with healthier economies abroad. Already, critics are pointing fingers—at the Fed, at supply-side theorists, at Wall Street. All of these critiques miss the mark.

Interest rates are high because the financial markets are not convinced that government economic policies have really changed. Government spending has been "slashed" by far less than the drop in government revenue from current tax-rate cuts—if those cuts failed to stimulate increased investment. Through 1986, absent supply-side revenue effects, the new rate cuts would mean $733 billion less in government revenues.

Because those supply-side effects will take time to occur, in the short term there could indeed be increased federal deficits. And deficits lead to one or both of the following: either the government borrows more money, crowding out private borrowers, thereby reducing productive investment; or the Fed monetizes the debt, in effect printing extra dollars. Since inflation is too much money chasing too few goods, either outcome is inflationary.

Wall Street's reaction is understandable. Given a national debt that just passed $1 trillion, a Federal Reserve that has exceeded its money growth targets four times in the past four years, a Congress that considers it a revolution to cut the rate of increase of federal spending, and an administration that seems determined to give the Pentagon a virtual blank check, it is not at all surprising that bond traders are skeptical.

True, the tax-rate cuts did not even begin until October 1; and yes, it does take time for people and firms to change their financial plans. But Wall Street is rightly skeptical of a "free-market" administration that can only promise to balance the budget by its fourth year in office. If you think that sounds disturbingly like what Jimmy Carter promised in his first year, welcome to the club.

What is needed is a fundamental break with the past—that is, with generations of welfare/warfare state big government. A program to restore a healthy economy, then, would be something like the following.

The first step would be to get serious about cutting back on government. That means doing more than trimming agency budgets and looking for "waste, fraud, and abuse." It means abolishing the legions of pork-barrel projects and special-interest programs by which we are all taxed to subsidize any interest group with a Washington office. Donald Lambro itemized $100 billion of such useless parasites on the body politic in his book Fat City: such gems as revenue sharing (since when do the deficit-ridden feds have excess revenue to share?) at $6.8 billion a year, the Small Business Administration ($2.3 billion), the notoriously wasteful EPA sewage treatment grants ($3.4 billion), farm subsidies ($13 billion over four years)—the list goes on and on. There are also hundreds of useless boards and commissions (for example, the US Metric Board at $3.1 million) that were untouched by the so-called slashing of the federal budget. And a recent mailing from Baylor University advertised one-day short courses on tapping into $100 billion in direct and guaranteed government loans still available after the Reagan cutbacks.

The second step toward economic recovery would be to take a hard look at this country's true defense requirements. The place to begin is with our military alliances with Europe and Japan. Thirty-five years after the end of World War II, it is absurd for US taxpayers still to be paying the lion's share for the defense of what have become our strongest economic competitors. A strong mutual defense, yes. But on terms that are mutually advantageous. It is Europe and Japan that are critically dependent on Middle Eastern oil, for example, not the United States. Why should US taxpayers bear the burden of adding that region to our defense perimeter?

Only after such issues are resolved can we define what strategic and tactical weapons systems are needed for our own defense. One thing we can be sure of is that they would cost a lot less than the $1.5 trillion the administration hopes to spend over the next five years. As the Wall Street Journal recently put it, it makes little sense to "keep pouring more and more resources into a fundamentally flawed structure."

The third ingredient for recovery is a restoration of sound money—and that means the availability of a currency convertible into gold. With increasing attention being paid to the recently appointed Gold Commission, even the New York Times is giving space to gold advocates such as Lewis Lehrman. And it's certainly a sign of the times when the normally Keynesian and solidly establishment Business Week devotes a cover story to the gold standard (September 21) and even concedes, editorially, that the administration "should not rule out a link to gold as the time-tested way to build faith in a currency."

The worst thing we could do is to opt for more intervention, as Senate majority leader Howard Baker and House GOP leader Robert Michel began urging in September, advocating credit controls and a new tax on interest. Interest rates are stuck because government plays far too big a role in the economy as it is. Only by drastically shrinking that role can we get the economy moving again. Abolishing government programs, rethinking defense needs, and restoring sound money will solve the interest rate debacle—not just this year, but on into the future.