The Wall Street Journal

OP-ED

April 19, 1995

Clinton Interest Gimmick to make Debt Much Worse

by Martin A. Armstrong, Chairman of Princeton Economic Institute

When Bill Clinton announced that he would cut the deficit by a projected $500 billion over five years, there was no screaming or cries of pain. Lobbyists were not weeping in the streets and nobody in the media claimed that children would starve. This miracle of miracles was accomplished in part by raising $250 billion, but also via a parlor trick—shifting the funding of the national debt toward short-term maturities to save on interest expenditures.

In 1990, 68% of the national debt was funded at five years or less. In 1994, 74% of the debt was funded at that term, with nearly 33% funded at one year or less. This manipulation created nearly $50 billion in savings on interest payments, since, at the end of 1993, 30-year bond rates stood at about twice that of on-year rates.

Multiply that by five years and you come up with a projected budget savings of $250 billion (assuming no change in interest rates). Add the tax hike and you get a projected deficit reduction of $500 billion over five years. This sleight of hand allowed Mr. Clinton to look like he was reducing government while in fact doing nothing of the sort.

The problem we now face is quite simple. Until the Clinton years, every administration since World War II tried to extend the national debt for as long as possible. This protected the budget from wild swings in interest rates while tending to reduce volatility as a whole. When the Fed sought to fight inflation, it had a two-to-four-year window before any interest rate hike would cause a surge in the nation’s deficit from interest expenditures. The Clinton debt manipulation has now endangered our economy, and the dramatic decline in bond prices last year is just the first warning sign.

With about 33% of the national debt now funded one year or less, and with short-term rates double those of a year ago, the deficit will rise far faster than anyone in Washington is prepared to forecast. The rise in interest expenditure could easily outpace the government’s ability to reduce spending. For every one-percentage-point rise in short-term rates, another $200 billion or more could be added to the debt by 1998. The immediate crisis in the dollar began when the balanced-budget amendment failed. The real international crisis is not currency, but debt. The widening deficit will once again become an issue for the capital markets.

To see the debt crisis in action, we need only look north to Canada, one of countless nations that have so squandered their national wealth that dramatic political change is forced upon them by the capital markets. Las year, 40% of every dollar the Canadian government spent went to interest. With virtually 40% of the entire national debt coming due by 1996 and short-term rates double those of a year ago, Canada’s interest expenditures will soar to 50% of total spending or higher, joining the ranks of Italy, Sweden and Mexico.

The concern over government debt is building world-wide as all industrialized nations continue to run bigger deficits. The old maxim that a national debt is merely a borrowing from ourselves died when holders of the debt ceased exclusively to be a nation’s own citizens. Interest expenditures of this magnitude are nothing more than a wholesale license to export the national wealth of a nation where government spending no longer stimulates the domestic economy.

Debt by itself is not necessarily bad, and it certainly does not cause a financial disaster alone. What is most important is how the debt is being used. The governments that are falling first are those where the greatest amount of spending has gone to social programs. If government spending fails to create good-paying jobs, the net effect is not a stimulus but a drain on the economy. Welfare recipients do not receive enough in transfer payment to buy a new home, automobile or other higher-end durable goods that create jobs. Combine this with the vast expansion of government itself (to 33% of the civilian work force), and you have the real reason for political unrest in America.

How can we get out of this mess? The US must:

• Make a concerted effort to shift the national debt back toward a long-term focus.
• Place an immediate freeze on government employment at all levels and start taking an honest approach to reducing the government work force.
• Implement a tax amnesty, with the proceeds used to retired the national debt.

And, finally, the long-term goal should be to abolish the income tax and replace it with a national sales tax—not a VAT—that is capable of extracting revenues from the underground economy, including illegal aliens. Under such a system, the upper class will naturally pay more, and exemptions for food and housing will protect the poor. This must be done with a simultaneous repeal of the 16th Amendment, which authorized the income tax.

Since the marketplace will not allow the US to shift its debt back toward long-term bonds without paying sharply higher interest rates, we must use another approach. Government bonds were always tax-free prior to World War II, save for partial taxation during World War I. To reverse the damage done by the Clinton administration, the Treasury should issue 10- to 30-year tax-free bonds in denominations as low as $1,000. Foreign holders of debt pay next to nothing in taxes on the interest derived in the US. It is about time the American people had the same privilege.

These should be nonmarketable zero-coupon issues. This would not only extend the national debt but also help to bring the debt home and slash the deficit in the current fiscal year. A portion of the savings in interest expenditures should then be used to retire short-term debt. This program would have the same net effect as a company buying back its own stock. The price of bonds would rise and interest rates would fall. A separate gold-backed bond could be offered at half the normal yield. Those who remain gold bugs would find this a reasonable way to own gold and earn interest too.

The Clinton debt crisis is real. This year along, interest expenditures may rise more than $60 billion—far outpacing any spending reductions the Republicans have in mind. Government taxation on all levels has been growing faster than the economy itself. If we do not start managing our debt in a professional manner, the capital markets will do the job for us—and the entire public debt sector of the world will be thrown into chaos as we go into the end of this century.