America's Balanced Budget Payoff

Pop quiz: When was the last time the U.S. government ran a budget surplus? It was 1969. Before that? 1960. The government even ran deficits in seven years in the '50s. Through Republican and Democratic presidents, the ink mostly ran red.

That's why the probability of a pact to balance the budget is a really big deal--one that corporations, consumers, Asian and European competitors, and, yes, even the global markets haven't yet fully appreciated. While all eyes are on the process, the financial and economic impact of the end product goes largely ignored.

Take interest rates. DRI/McGraw-Hill has simulated the impact of a budget balanced by 2002. Long-term interest rates will drop about two percentage points. The 30-year bond, now at about 6.5%, will go to 4.5%. The prime rate, currently at 7.5%, will fall to 5.5%. And 30-year mortgages, now going for 7.5%, will decline to about 6%. The nation will shift from a loose fiscal, tight monetary policy to a tight fiscal, loose monetary one for the first time in decades. That's great not only for housing but for all kinds of business investment. Better yet, the country doesn't have to wait seven years for the interest-rate bonus. Once the markets are convinced of the surety of fiscal discipline, the gains will come fast and furious.

Take stocks. Without a balanced budget, the Standard & Poor's 500-stock index, now at 544, will rise to about 700 by the year 2002, according to DRI/McGraw-Hill. But with a balanced budget, the S&P index jumps to 900 in seven years, 27% higher. Again, the gains come quickly. By 1997, the S&P index is up to 670 instead of 560, generating billions in new wealth.

Price-earnings ratios, of course, will be a lot higher, too, if competing bond yields fall sharply. In today's world of 6.5% long bond yields, p-e ratios in the U.S. are in the range of 16-17. Once rates drop to 4.5%, p-e ratios bump up to 20-21. For Corporate America, this is heady stuff.

So while following the drama on the Hill, keep in mind that the endgame has great significance. A balanced budget is about to help an economy already in a capital spending boom, with low inflation, high productivity, and a surging info-tech sector. Caveats about economic cycles aside, 6000 Dow, anyone?

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