In this morning’s Wall Street Journal former Federal Reserve Board governor Lawrence Lindsey says “the deficit is worse than you think.” (see: http://tiny.cc/2q8wx) But rumors around Washington and Wall Street suggest that Lindsey’s is the optimistic scenario. To see why, let’s start with what he says.
His argument is simple: the Obama Administration’s projections incorporate four flaws.
First, they assume that interest rates will continue at or near their current historic lows. Today the Treasury’s cost of borrowing is less than half its ten-year average. Assuming interest rates return to the norm in the next several years adds close to $5 trillion to interest costs, and the deficit.
Second, the Administration assumes that the economy will grow at or over four percent every year, growth that we are nowhere near achieving. Missing that forecast by one percent in any year costs $750 billion. Using more realistic growth assumption (but still optimist by recent experience), in just the next three years, the government will take on $4 trillion more than projections.
Third, no surprise here, Obamacare will be wildly more expensive than any price the White House will acknowledge. A recent McKinsey survey found that 30 percent of employers would dump their private insurance once the government plan kicks in. The result will be at least $1.5 trillion in extra federal spending every two years.
Finally, tax increases cannot possibly make up for the kind of excess spending numbers we have been seeing.
The administration probably knows all this, and Congress certainly does. The last Congress – the one that Democrats controlled – failed to pass a budget. But now the Democratic administration has failed even to submit a budget, at least a credible one. The Senate rejected their first try 97-0. Then the president gave a speech that was, he said, part of presenting a new budget with $4 trillion in spending cuts. But he has never specified the cuts. When the head of the Congressional Budget Office was asked for the office’s estimates of the president’s proposal, he replied, “We don’t estimate speeches.” And he’s a Democrat.
This is all bad news. But waiting in the wings is news that is worse.
Two weeks ago I wrote about a conversation I recently had with a former senior Treasury official (see http://tiny.cc/s963h). His service had been in the Reagan era. The official had noted that the Treasury has not been selling 30-year debt, despite extremely low long-term interest rates. He suggested that the only reason would be that the department fears failure of a long-term bond auction, sparking a market panic.
The column led to an invitation to appear on Varney & Company, the Fox Business program hosted by Stuart Varney, one of the sharpest financial journalists of this time. Varney questioned me closely about my report, asking at one point did I believe market rejection of Treasury debt was likely. I said I thought not, but that I believed Treasury was just uncertain enough not to want to test fate. Now I feel I may have been too optimistic.
In the last two weeks, financial community sources have suggested to me that conditions are worse than the first story indicated. All new Treasury debt with maturities longer than two years, one said, is being bought by the government itself, meaning the Fed or government controlled trust funds. The average maturity of all new debt that ends up in non-US government hands is under two years.
One source speculated that the Administration is straining every muscle and nerve to keep the extent of market dismay at the U.S. government’s financial condition and expectations of exploding inflation from public view until after the 2012 election. Another suggested that the motive is less political and more fear of the economic and financial market fallout. But obviously these are not either-or motivations.
In the last few days, the president has said that he will become directly engaged in budget talks, something he has declined to do until now. But based on his performance in office to date, it is questionable whether he actually knows how to negotiate. Has he ever seriously engaged in the give and take of policy talks, even within his own party? Repeatedly he has passively accepted legislative packages that Democratic leaders in Congress have laid out, then rigidly refused to adjust to additional views. This is not negotiation.
So here is where we end up. A crisis in government finance may be closer than we believe. And the administration may be less capable than we expect to cope with it.
It brings to mind the old Laurel and Hardy line: “Well, this is another fine mess.”