Late April brought some seemingly good news for the Bush economic team. Gross domestic product increased by 5.8 percent, the largest jump in two years. But beneath this encouraging sign are deeper problems that point to greater economic turbulence ahead.
President Bush himself seemed to understand that the economy has not yet made a full comeback to the strength of the Clinton years, though he would never put it in quite those terms.
"I'm not content with this number," Bush said on April 26. "We must continue working to make sure the short-term recovery is a long-term recovery."
But it is Bush's own economic policies that are endangering that long-term recovery. With the spike in security spending post-Sept. 11, planned spending is up 15 percent in the president's first two budget proposals. Not since Lyndon Johnson tried to run both the Vietnam War and the Great Society at the same time has spending grown so prodigiously. Johnson's runaway spending, and lack of fiscal discipline needed to pay for it, produced the economic train wreck of the 1970s.
The Bush tax cut betrays a hauntingly similar lack of discipline. On top of the current spending spree, the tax cut will drain almost $4 trillion from the U.S. treasury by the end of the decade. That's when baby boomers begin retiring and start making record demands on Social Security. That's when we need the government to be in the best financial shape possible, but that is exactly what the combination of increased spending and lavish tax cuts/payoffs for the rich are threatening to undermine.
If there is a single lesson we should have learned from the supply-side debacle of the 1980s, it is that you cannot raise spending and cut taxes without producing massive deficits. And if you do produce massive deficits, the economy will suffer. Why this should be an epiphany for so-called conservatives is surely one of the mysteries of the modern age. Again, the data speak for themselves. During the 1980s, our cumulative national debt, which had taken 200 years to reach $1 trillion, suddenly quadrupled to over $4 trillion.
To finance this record domestic debt, we had to borrow furiously from abroad. In the process, we went from being the world's largest international creditor to being the world's largest international debtor. Finally, in October 1987, when the Japanese figured out that the dollar was losing value faster than their U.S. investments were appreciating, they withdrew their money from U.S. markets, producing in the process the worst stock market crash since the Great Depression.
The financial markets understand this logic all too well. Their response is beginning to look ominous. The stock market is down over 10 percent since Bush took office -- despite the fact that it now appears there was never an actual post-Clinton recession at all. The market just returned its worst April performance since 1970. The S&P 500 is down 7 percent this year alone and if it doesn't correct by December will produce the worst three-year return in this index since World War II. The rate on the 30-year treasury bond is up 16 percent in the past six months. Remember, when things cost more, people buy less. Unemployment just hit its highest level in eight years and is still rising. Consumer sentiment has begun to fall.
In other words, the people who vote with their money are turning thumbs down on the Bush economic program.
Even the good GDP numbers come with an asterisk. More than half of the new growth comes from inventory replacement -- merchants restocking shelves that they'd let go bare last year. Inventory replacement does not represent goods actually being sold to real consumers. Only that final sell-through is the basis for sustaining GDP growth, and that number has yet to come in. The other concern is that this number is based on preliminary sample data and is only the first one released by the government. Over the next nine months, as the data become more complete, the GDP number will be revised twice, perhaps substantially. If the statisticians mark the number down -- and they commonly do -- the early basis of euphoria will evaporate.
But there are even greater reasons for concern about the economy. The biggest problem is the sudden deterioration in the federal budget. Last fiscal year, the government ran a $127 billion surplus. Within the last week, however, analysts began suggesting we might see a $100 billion deficit in the coming fiscal year. In other words, in just over a year, the balance in the federal budget has swung to the worse by $227 billion. This staggering reversal signals a serious problem for the future of the economy.
When the government runs large deficits, it sucks available capital out of the economy. Economists call this the "crowding-out effect" because government borrowing crowds out private borrowing. The resulting shortage of money causes interest rates to rise. When interest rates rise, all of the costs of doing business rise right along with them. Factories cost more. Inventories cost more. Houses cost more. Cars cost more. And when things cost more, people buy less of them. The converse is also true: When interest rates decline, the costs of doing business decline as well, so people do more of it. They buy more homes, cars, factories, etc. We don't have to take this on faith. Recent history offers an almost perfect illustration of the workings of this economic law.
Bill Clinton inherited a $292 billion deficit from George Bush the elder. In his first budget, Clinton defied every Republican in Congress to raise taxes and begin paying down this deficit. Proclamations of the apocalypse rained from Republican lips. But by the end of his presidency, the government was running $250 billion surpluses.
The extra money was used to begin paying down the $4 trillion national debt Clinton had also inherited. By resolutely turning deficits into surpluses, Clinton freed up $1.46 trillion for use by the private sector. The effect on interest rates? The price of 30-year, fixed-rate loans fell by more than 40 percent. This is where the housing and capital investment booms of the '90s came from: Interest rates were lower and people bought more. The ultimate result of this surprisingly fiercely resisted fiscal discipline was the longest economic expansion in U.S. history. Total U.S. government debt declined for the first time since 1969. Workers' incomes rose across the board. Growth accelerated. Industrial productivity soared.
And even with its recent correction, the stock market more than tripled. If ever there was a golden age of U.S. fiscal management and economic performance this was certainly it.
Unfortunately, the Bush economic program threatens to reverse that trend. Bush's promoters in the media want to ignore this unpleasant fact, chirping happily about fictive GDP numbers while the more ominous rot in the president's budget goes mysteriously unheralded. But just as they were for Johnson and Reagan and Bush the elder, the facts are persistent and, in the long run, irrepressible. This is not a matter of politics; it's a matter of economics. As with politics, however, we need to look beyond just the "good" news to understand the real story. It is not a pretty picture.