Collision Course

For weeks, President Clinton and his Republican adversaries in Congress have been sounding alarms about a fall Armageddon over the federal budget. They're conjuring up specters of a government shutdown, 2 million workers laid off--and a default on Treasury debt that would make the mighty U.S. look like a banana republic.

Sure, similar scare talk has surfaced in past budget battles, and the nation has survived brief federal shutdowns without mishap. But the odds of a damaging fiscal "train wreck" seem greater now: This budget fight pits competing visions over the very nature of government, and the combatants are willing to risk a prolonged crisis to prevail. "There's a different feeling this year," frets one longtime congressional aide. "An awful lot of people seem to be looking forward to a meltdown."

That kind of talk has made normally unflappable central bankers nervous. Indeed, top Fed officials worry that the odds are rising that--for the first time in history--the government will default on its debt. However brief, such a default could result in tens of millions of dollars in higher interest payments. One top Fed official estimates that missing payments could push up rates on Treasury securities by a quarter point or more.

OVERBLOWN CONCERNS? Wall Streeters are starting to twitch as well. "You just can't tell where the fallout would stop," says Louis Crandall, chief economist of R.H. Wrightson & Associates, a research firm. "It's the equivalent of shouting `fire' in a crowded theater." Philip Braverman, chief economist for DKB Securities Corp., figures foreign buyers would be the first to run for the hills: "If holders can't get timely payment, and the bonds don't have liquidity, it does raise a premium overseas."

All this concern may prove overblown. After all, it's not unusual for two sides headed for an intense negotiation to start off with a lot of bluster. Budget gridlock has forced the government to shut down nine times during the past 15 years, although mostly on weekends and never for more than four days. But this year, the principals sound as if they are armed for battle. "The budget fight for me is the equivalent of Gettysburg in the Civil War," House Speaker Newt Gingrich told BUSINESS WEEK in a May interview. And Clinton refuses to back down. "I will not be blackmailed into selling the American people's future down the drain to avoid a train wreck. Better a train wreck," he told National Public Radio on Aug. 7.

The nut of the conflict: Gingrich & Co. have vowed to slash government and dramatically cut taxes--for rich and poor alike. Clinton believes that voters want a smaller government but that they also want him to save programs such as health care for the poor and elderly, education, job training, and environmental protection. He also believes that tax cuts ought to be targeted at the middle class and not the wealthy (table).

Both Clinton and the GOP are convinced that by heading full-speed down the tracks, they can force the other side to hit the brakes before a collision. Republicans, says White House Chief of Staff Leon E. Panetta, "feel they get maximum leverage if the President is faced with a choice between accepting their package or a government shutdown."

"TEST OF WILLS." The feared fiscal crisis would come in two steps: The first would hit in early October and could result in a brief shutdown. Most of the government, except for entitlement programs such as Medicare, Medicaid, and welfare, is funded through annual appropriations, and many agencies must close if money isn't approved by Oct. 1, the start of fiscal 1996. The House has passed most of those 13 spending bills. But Clinton has threatened to veto six.

In many ways, this part of the dispute is mere theatrics. The President is willing to accept roughly 97% of the House's proposed $270 billion in domestic spending. The differences could be settled in a few days. But with an election looming, the battle is over more than how to divide $8 billion. "This will be a test of wills," acknowledges one top White House aide.

The bigger battle will come over taxes and health care, where a vast gulf separates Clinton and the GOP. Congress won't complete its so-called reconciliation bill--the portion of the budget that controls taxes and entitlements--until October. Sometime between late October and mid-November, just as Congress and the White House attempt to resolve their differences, the Treasury will hit its statutory debt limit of $4.9 trillion and be barred from borrowing new money. When that happens, Washington will be unable to repay maturing debt or interest on existing paper. In short, the U.S. would become a giant version of Orange County, Calif. "I don't think there should ever be a circumstance in which there's a perceived risk of default by the U.S.," warns Treasury Secretary Robert E. Rubin.

Default not only would hurt U.S. treasuries but also could scramble the derivatives markets, pound the dollar, and seriously squeeze bank liquidity. The Treasury and Fed could delay the crisis a few days by manipulating government accounts, and the White House is looking for ways to avoid default by executive fiat. But odds are that when a big interest payment comes due on Nov. 15, the debt ceiling will have to be increased--or the government will slide into default.

Republicans say they are perfectly willing to set off such a crisis in order to win concessions from Clinton. More than 150 House Republicans have vowed to oppose any hike in the debt limit until Clinton signs off on their plan to balance the budget by 2002. In the Senate, Presidential hopeful Phil Gramm (R-Tex.) vows, "I am going to oppose any effort to simply extend the debt ceiling. If we shut down the government for a few weeks, people may decide they don't want it back. It's not the end of the world."

ANGRY VOTERS. But it could be the end of the GOP's hard-won majority in the House. While a government shutdown and default surely would hurt Clinton, some Republican strategists worry that the crisis could damage the reelection chances of freshmen Republicans who roared in on a tide of voter resentment against a do-nothing Congress. A November shutdown would only intensify that anger. "It would be a triumph of ideology over sound political calculation," says political scientist Steven E. Schier of Carleton College, in Northfield, Minn. "It may cost them their jobs." The winners, in that event, would be congressional Democrats, who would avoid big domestic spending cuts this year and gain seats in the upcoming election.

That prospect, plus pressure from Wall Street and Main Street, could bring Clinton and the Republicans to the negotiating table before a full-blown crisis. But as time drags on and rhetoric heats up, it seems likely that they won't begin talking until after a smashup.

Heading For Trouble

Flash points between President Clinton and Congress

EDUCATION House Republicans would reduce funding for the President's favorite top education program, Goals 2000, by 80%. Clinton would double spending on the program.

MEDICARE Congress wants to slash projected Medicare spending by $270 billion over seven years. Clinton proposes trimming the program by only $124 billion.

TAXES Congress would cut taxes by $245 billion over seven years. Clinton backs cuts of just $100 billion, mostly

targeted at America's middle class.

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