Soaring Deficit Starts To Frighten America's Voters

The battle over regulatory reform of the financial sector has lost some of its urgency, now that the banks have paid back their bailout money, and most executives have reconciled themselves to taking their bonuses in the form of shares that must be held for a few years. The remaining battles over which regulator will regulate whom is of more interest to the affected institutions and Congress than to the public.

This means that voters’ attention will focus more on the burgeoning budget deficit. And soon. Early in the new session, Congress will have to raise the statutory limit on the federal debt lest the government be unable to pay its bills and shut down. It will set a new higher ceiling, but not before the magnitude of the unfolding deficit problem is played out in television interviews and newspaper editorials.

Talk in Washington is that the Senate will require any new spending to be offset by tax increases or cuts in other spending, and that a commission be set up to devise ways of bringing the deficit under control. The House is less predictable: it can be counted on to reinstate the estate tax, which expired at the end of last year, and to resist any effective constraints on future spending.

That debate will be only the opening round in a discussion about the gallons of red ink pouring over the nation’s ledgers. The Obama administration is saying that the deficits will total more than $10 trillion through 2019, bringing US public debt to almost 110% of GDP, a level not seen since the end of the second world war. And that doesn’t include the need to do something about Medicare and social security (pensions), which will be out of funds by 2027 and 2037, respectively.

That might sound like dates too far ahead to worry about just now but investors, surveying the fiscal scene, have already started to react to the combination of the present deficits — Obama has put himself in a class with Gordon Brown and Greece’s George Papandreou by running deficits of more than 12% of GDP — and the lack of a coherent plan to get them under control.

Even the president’s staunchest supporters worry. John Podesta and Michael Ettlinger, president and vice- president, respectively, of the left-leaning Center for American Progress, took to the pages of the Financial Times to fret:

“The deficit is projected to drop in the next few years, but never below 4% of GDP; in 2014, the shortfall is expected to be at least $700 billion. After hitting a low in the middle of the decade, it will rise for the rest of the decade and beyond. The mere anticipation of such a large, sustained deficit poses risks to financial markets and the economy, and undermines US standing.”

Worse still, this grim appraisal assumes that the administration’s budget projections are reasonably accurate — most dispassionate observers say they are wildly over-optimistic.

Economists agree. At a meeting of the American Economic Association, a panel of distinguished economists said that the fiscal situation “frightens all of us”.

It undoubtedly also frightens Ben Bernanke, the Federal Reserve chairman, and at least some of his colleagues. They have been keeping interest rates close to zero to encourage borrowing and to make cheap funds available to banks to re-lend, so that they can build up their profits and capital bases. And they have been printing money with which to buy all those government IOUs.

The Fed says it knows how to cut back on all its stimulus policies, but is waiting until it is certain the economic recovery is sustainable, and the job market is on the mend. But if the federal government keeps spending as if tomorrow will never come, the Fed will have to make its move sooner rather than later. With no end in sight to huge deficits, with the rating agencies warning that America’s triple-A rating is not a permanent gift, but an honour to be earned and re-earned, the Fed might, just might, feel obliged to tighten sooner and harder than it otherwise would. Once the economy is growing steadily — it seems likely to have racked up a 4% annualised growth rate in the final quarter of last year — the Fed might feel uncomfortable throwing the kerosene of cheap money onto the flames created by large deficits.

Voters have been disturbed by the deficits, but now that other agenda items are checked off, they will focus even more intently on the administration’s spending. Not that the specific numbers, or the specific proposals, will be etched on the memories of any people other than full-time political geeks. Instead, most voters understand something more human than policy wonks’ talk of pay- as-you-go plans to require new spending to be deficit neutral (unenforceable), or a line-item veto that allows the president to veto specific items in the budget (unattainable), or wasteful spending (inevitable). They don’t like the idea of leaving a huge bill for their children and grandchildren to pay.

The president and Congress have no such compunction. Indeed, with the 85,000 drop in employment in December, Congress is pushing for a second stimulus package. Rather like Britain’s politicians, the time horizon of our lawmakers is the next election, not the coming of age of their grandchildren. Which is why spending is for now, and deficit reduction for another day. That strategy just might backfire. The fragile recovery could come to an abrupt halt if the Fed is forced by a profligate government to tighten too soon. And with it the recovery, and the public lives of more than a few politicians.