A New Pre-Emptive Doctrine

In other commentary pieces, I have expressed the view, influenced by Paul Krugman's New York Times column, that the United States is heading for financial meltdown along the lines of Argentina and Brazil in the 1980s and 1990s and early 2000s. Recently, these opinions have been supported in both a paper presented to the American Economic Association by Robert Rubin, Peter Orszag and Allen Sinai as well as in a Congressional Budget Office (CBO) publication. My opinion (as well as theirs) is based on the long-term potential for high budget deficits, which could erode domestic and foreign confidence in the ability of the U.S. government to service its debt. This loss of confidence, which could occur suddenly, as it did in Argentina and Brazil could lead to a "shift in portfolios away from dollar-denominated assets and put downward pressure on the dollar and upward pressure on domestic interest rates" which could "increase the nation's net exposure to substantial exchange-rate changes" (Rubin, Orszag and Sinai 2004, 12). The shift away from dollar-denominated assets, in particular U.S. Treasury Notes, Bills and Bonds, would result in an increase in the interest rates needed for investors to be willing to hold these assets, further hurting the ability of the U.S. government to service its debt. The added exchange-rate instability would further hasten the process.

The end of the process would be spillover effects into the real economy. This would also hurt the crisis: an economic crisis would reduce government revenues and increase the federal government deficit. Even N. Gregory Mankiew, Chairman of Bush's Council of Economic Advisors wrote before he was obliged to support the Bush policies by accepting the position wrote that "the fears [about hard landings] may be the most important reason for seeking to reduce budget deficits". He and Laurence Ball also advised that "if policymakers are prident, they will not take the chance of learning what hard landings in G-7 countries are really like" (Ball & Mankiew 1995, 117; cited in Rubin, Orszag and Sinai 2004). They too saw they dangers of high long-term budget deficits. Rubin, Orszag and Sinai also criticize the Bush Administration and its supporters who have argued that cuts in discretionary spending should be used to fill the gaps. One only has to look at recent headlines, such as the New York Times headline "Bush's Budget for 2005 Seeks to Rein In Domestic Costs". Furthermore, many, including Paul Krugman, have suggested that the policy of large tax cuts is geared to force a fiscal crisis that will make cutting entitlements politically acceptable. Rubin, Orszag and Sinai suggest that that policy, as well, could be disasterous, whether or not it succeeded, on long-term U.S. economic growth, not to mention the social impacts.

Overall, however, budget deficits are not bad. Short-term budget deficits can be useful during recessions. Rubin, Orszag and Sinai note that "The most attractive policy combination to spurring demand in a weak economy with excess capacity of capital and labor would thus combine long-term fiscal discipline with short-term fiscal stimulus" but that "too much fiscal stimulus extended over too long a period raises questions about whether long-term fiscal discipline will occur, thereby undermining the efficacy of such a joint package" (Rubin, Orszag and Sinai 2004, 12). That is almost a perfect criticism of the Bush tax cuts of 2001, 2002 and 2003: little immediate stimulus with damage to prospects of long-term fiscal discipline. What is needed is a policy of pre-emption to combat long-term deficits.

Ball, Laurence and N. Gregory Mankiew. 1995. "What Do Budget Deficits Do?" In Budget Deficits and Debt: Issues and Options. Kansas City: Federal Reserve Bank of Kansas City, 95-119.
CBO. 2003. Long-Term Budget Outlook, December
Center on Budget and Policy Priorities. "Is Domestic Spending Exploding?", January 7, 2004.
M�hleisen, Martin and Christopher Towe. 2004. U.S. Fiscal Policies and Priorities for Long-Run Sustainability. IMF Occasional Paper 224.
NYT, I.M.F. Report Says U.S. Deficit Threaten World Economy, January 7, 2004.
NYT, "Bush's Budget for 2005 Seeks to Rein in Domestic Costs, January 4, 2004.
Rubin, Robert E., Peter R. Orszag and Allen Sinai. 2004. Sustained Budget Deficits: Longer-Run U.S. Economic Performance and the Risk of Financial and Fiscal Disarray. Paper presented to the American Economic Association, January 4, 2004.
Goud, Jr., Richard B. "Domestic Spending and the Deficit", December 16, 2003.
Goud, Jr., Richard B. "Budgetary Crisis", September 28, 2003.

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