January 13, 2004,
The Bush administration got hammered on its fiscal policy last week. First, former Treasury secretary Bob Rubin came forward with a study (co-authored with Peter Orszag and Allen Sinai) warning that the budget deficit could lead to a loss of confidence in the dollar, which could lead to a disruption in financial markets. New York Times columnist Paul Krugman said the study proved that the United States is becoming a Third World country like Argentina, and could soon suffer a financial crisis similar to the one the currently grips Argentina.
Then the International Monetary Fund issued a paper warning about the unsustainability of the deficit. The New York Times hyped it on page one (above the fold). Although the IMF said there was nothing new in the study beyond what it has said repeatedly in its Article IV consultations, the Times made it seem as if the U.S. budget deficit were the world's single greatest problem today. Every other paper I saw took a different view, burying the story in the back pages of the business section, where it belonged.
Of course, the idea that no one in a position of authority is aware of the budgetary situation is ludicrous. The Congressional Budget Office and the General Accounting Office issue reports on the subject all the time. I don't say this to minimize the problem, but rather to question why it has suddenly arrived on page one of the nation's leading newspaper.
The answer is politics. The liberal New York Times, which often operates as a think tank for the Democratic party, and Bob Rubin, who served under Bill Clinton, are laying the groundwork for a political assault on President Bush over his budget policies. They hope to give the Democratic presidential candidate an issue to run on that could propel him into the White House.
It isn't as though Bush isn't vulnerable on the issue. Clearly, he has been inattentive to the growth of spending on his watch, and most conservatives think he made a grave error in pushing a massive new Medicare drug benefit through Congress. But people like Rubin are not concerned about that they are concerned only about Bush's tax cuts, which they blame entirely for any fiscal problems the nation may have.
Fortunately for Bush, none of those seeking to challenge him in November seem capable of scoring any points against him on the deficit. There is no Ross Perot running for the Democratic nomination. Although all would rescind Bush's tax cuts to one degree or another, none have said that the additional revenue would be dedicated to deficit reduction. Rather, they would all use the money to cut taxes in some other way or to pay for new government spending.
Rubin, who is certainly one of the smartest men in the Democratic party, knows this, but he is calculating that some unforeseen financial event may change the dynamics. The key element of his paper making it different from other such analyses is that it raises the question of confidence in the dollar and U.S. financial markets. If there is a stock market crash, like those in 1987 and 1989, some time before the election, the deficit could indeed become a hot political issue that the Democratic candidate might be able to exploit.
This is not an unrealistic possibility. I have been saying for some time that inflation and interest rates are going to rise as the economy picks up steam. Sometimes markets ignore such trends for a long time and then take notice of them all of a sudden. This could lead to a sharp readjustment in the stock market at some point. If history is a guide, whatever the true reasons for the market break, policymakers inevitably will focus on the budget deficit as the underlying cause. That is what happened in both 1987 and 1989.
Such a scenario is unlikely, however. All indications are that economic growth will be strong this year, leading to a higher stock market. The deficit will have to be dealt with after the election, but until then there is no reason to believe that it threatens either the economy or Bush's reelection prospects.