The World's Biggest Credit Hog: Washington

So you're kicking yourself for missing the low point in interest rates in January, when you could have refinanced your 30-year mortgage at 8%? Wall Street says relax, that the two-month rise in long-term interest rates is temporary. But some economists say you have reason for regret. They figure inflation-adjusted interest rates will remain high for years.

These purveyors of gloom are focusing on the one topic no one wants to talk about in this year of recession and election--the federal budget deficit. At $400 billion now, even economic recovery won't push the tide of red ink back very far, analysts say. Indeed, the Bush Administration itself foresees a $182 billion deficit in 1997.

So as private investment picks up with a recovering economy, government will be hogging the supply of credit (charts). And overseas investors won't provide new capital. "The only way the market can clear is with higher rates," says Irwin L. Kellner, chief economist at Chemical Banking Corp.

UNNERVED. That's got the Federal Reserve worrying that high rates will squash an economic rebound. Fed Chairman Alan Greenspan has stepped up his criticism of Washington's tax-cutting fever, which Fed officials say spooked bond investors. Vice-Chairman David W. Mullins Jr. says the surge since January in 30-year T-bonds, from 7.45% to more than 8%, was caused by fears of tighter credit through 1997--the period when the deficit will crowd out investment. "The markets are signaling big increases in rates as the deficit and the recovery collide," Mullins says.

Crowding out has been an economic bogeyman since the mid-1970s, when the budget slipped permanently into the red. In the early 1980s, economists thought the government's demand for money would strangle the economy. But foreign money, attracted by high rates, saved the day.

That's not going to happen this time. Today, long-term rates are high relative to inflation all around the globe, and international spreads have narrowed. U.S. and British elections, weak governments in France and Italy, and Japan's recession "add a big premium to rates," says David H. Resler, an economist for Nomura Securities International.

SAYONARA TIME. Farther out, European money will go to the former Soviet bloc. And the 1980s' biggest buyers of U.S. bonds, the Japanese, reversed ground and liquidated $19 billion in Treasuries in 1990 and 1991. "They need the money to shore up their mwn finances," says Steven H. Nagourney of Lehman Brothers.

So the U.S. must find its own way to ease the coming capital crunch. Fed Governor Wayne D. Angell says lower inflation and high real rates will boost savings. Deleveraging--slashing debt and boosting equity--will do the same for business, says First Boston Corp. economist Lars J. Pedersen, who predicts that the U.S. will soon be exporting money.

But "we can't dig out of a decade of debt in a hurry--and on the federal level, we're not even trying," observes David A. Wyss, financial economist for DRI/McGraw-Hill. Instead, most politicians seem interested only in economic growth. But without tough action on the deficit, high long-term rates may keep the pols' wish from coming true.

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