The Budget Is Still The No. 1 Priority

Low interest rates are the sweet elixir of economic growth. They do magical things, such as promote capital investment, new jobs, and higher stock prices. Low rates make possible the stuff of the American Dream--home ownership.

Even as the U.S. wrestles with economic anxiety, home ownership is taking off, reversing the calamitous decline of the 1980s. Home buying has been on the upswing bolstered by minorities and immigrants. But the stronger housing market is threatened by the recent run-up in rates. Furthermore, the market is toppy because stocks are facing stiff competition from higher-yielding bonds. Those higher rates will almost certainly crimp corporate earnings, further depressing equities.

Who's to blame? A few fingers point to the hedge-fund managers and Japanese banks that played a global yield-curve game. In January, they borrowed money in yen in Japan, where interest rates are 1%, and bought U.S. Treasuries in dollars at 6%, pocketing the profit. Then the Japanese economy began to show signs of recovery, there was talk of the Bank of Japan hiking rates, and the hedge funds bailed out. U.S. bonds cratered, with long-term rates jumping to 6.7%.

But it is Washington that is undermining the fundamentals. This was the year rates were supposed to fall, thanks to a balanced-budget deal. Amazingly, the politicians flubbed it. Then came the primaries. One Republican ran as a flat-taxer, saying deficits didn't matter. Another ran as an anti-big-business protectionist, with tariff policies that would raise inflation and rates. The result? Confusion in policy and volatility in the markets, with stocks bouncing around and bonds falling. The bond vigilantes, happy to see fiscal discipline in Washington last year, don't see any now. So they want an extra premium and a big one. At 6.7%, 30-year bonds are 4.7% above inflation, as measured by the consumption price deflator, which is down to a mere 2%. This is nearly twice the historic spread.

The budget deficit is one reason for our underachieving economy, where growth rates rarely rise above 2% to 21/2%. A deficit deal would allow the U.S. to grow faster, providing jobs for the young and their downsized parents.

That's why the emergence of Bob Dole as the likely Republican candidate could be good news. Dole has been against deficit spending for most of his career. In fact, Dole may already have emerged from the primaries with enough clout to reach a budget deal with President Clinton before November. That would enhance the stature of both candidates--and bring a smile to the faces of stockholders and home buyers.

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