Welcome to America's first international debt crisis. It may look like a plain old dollar crisis, with the buck plummeting against the Japanese yen and the German mark, setting off wild currency gyrations in Europe and bumping up the price of gold and platinum. But it's much worse than that.
The cold-war legacy of gigantic twin towers of debt-- from never-ending budget and trade deficits--has generated a humongous overhang squashing the world's financial markets, subverting demand for dollar-denominated securities and dollars. Congratulations, America, the hot-money folks who send trillions around the world every day have just voted to make the U.S. part of the global debt set, along with Brazil, Canada, Spain, Sweden, and, of course, Mexico. The current dollar crisis is just the first taste of a capital boycott by the new international creditor class. If the U.S. doesn't act quickly and appropriately, we just may be looking at the start of the next recession, or worse.
Oddly enough, the economic fundamentals in the U.S. are quite good. Productivity is back up, the nation leads in technology, inflation is low, corporate profits are zooming, and companies are so competitive abroad they are chalking up record exports. But the sins of the past have gained a life of their own. There are now trillions of dollars of outstanding U.S. debt, much of it owed to foreigners. That debt is compounding every minute. If it weren't for $203 billion in interest paid on the federal debt in 1994, the budget would actually have been in balance.
NO ROOM FOR "KILLER" RATES
Mexico was the last straw. The rescue package, a feeble product of a divided government in Washington, pushed the dollar over the edge. To the hot-money traders, the package appears to make the U.S. Mexico's lender of last resort, responsible for that country's huge foreign debt as well as its own. Worse, the $20 billion in U.S. financial aid comes from the Exchange Stabilization Fund--the same pool the Treasury traditionally uses to support the dollar in currency markets. No one knows now how much is available to battle the speculators. To the foreign exchange markets, the whole sad enterprise smacks of the "peso-ization" of the dollar.
The currency vigilantes want blood, and no American policymaker should doubt that the U.S. will have to give it to them, one way or another. The discipline of the market is imposing a stark choice: cut spending or raise interest rates. The Federal Reserve can impose "killer" interest rates that make investing in U.S. government debt so attractive that foreigners will take yet another chance in dollar-denominated securities. But with the economy already showing signs of slowing down, that could easily kill off growth entirely. If there is anything the U.S. doesn't need, it is this recipe for joblessness.
Better to tackle the twin deficits. However maladroit the balanced budget amendment might have been economically, it had the virtue of being persuasive. It was a constitutional mandate that Republicans wanted for pressuring recalcitrant legislators to cut programs favored by constituents. That is now gone, and a new mandate is needed. This currency crisis should be seen in Washington for exactly what it is--a global mandate demanding constraint on spending.
THE DEBT GAME IS UP
Unfortunately, after the defeat of the balanced budget amendment in the Senate, the Republicans appear to be wavering on spending cuts. With Democrats posturing about protecting Social Security and with Republicans worrying about losing their political cover, the smart money in Washington is betting that little progress will be made on balancing the budget until after the 1996 Presidential election.
That isn't acceptable. The markets won't permit it. Instead of political posturing, Washington politicians should level with the voters. The worst canard being perpetrated by both parties is that middle-class tax cuts are needed. They might help distressed families, but each tax dollar cut makes balancing the budget harder. Despite this, both President Clinton and House Speaker Newt Gingrich continue to promise hundreds of billions of dollars in new breaks.
Truth is, the government simply must curb its largesse. Spending on middle-class entitlements and mandatory programs has nearly doubled in the past 10 years. More than half the $1.5 trillion of federal spending now goes to fund these programs. More and more, budget deficits are caused by high interest payments to service past debt and by rising payments for Medicare and Medicaid. That can't continue. The fee-for-service luxury of Medicare and Medicaid has to be replaced by moving the elderly and needy into health-maintenance organizations or preferred-provider organizations, saving nearly $400 billion over a period of seven years. Rationalizing and limiting entitlement programs for farmers, veterans, business, and the poor can save hundreds of billions more.
The chronic trade deficit must be confronted as well. During the cold war, military and political containment of communism took precedence over economic affairs. The U.S. ran the most open of economies, acting as an engine of growth for the more closed nations of Europe and Asia. With the end of the cold war, it is no longer in the national interest to accept mercantilism anywhere in the global community. Indeed, the structural trade deficit that the U.S. runs with Japan and China has built up a mountain of foreign debt. It makes the U.S. dependent on capital inflows from abroad--and vulnerable to pressure for higher interest rates and slower growth. That's what the current dollar crisis is all about.
The dollar crisis demands facing harsh truths. It is a mandate to cut America's twin deficits and begin its long trek back to becoming a creditor nation once again. Carpe diem.