Los Angeles Times
July 2, 2004
The plan was: a $400-billion federal budget surplus this year, and a national
debt of $2.1 trillion heading rapidly to zero. That was the plan in January
2001, when President Bush took office. And not just the plan: that was the
official prediction of the nonpartisan Congressional Budget Office.
Now we have a new plan. Instead of a $400-billion surplus, Bush's budget calls for a $500-billion deficit. The national debt is $4.4 trillion and headed to more than $6 trillion over the next 10 years, according to the CBO. Interest on that debt will cost $156 billion this year. Bush says he'll cut the deficit by half in four years. The deficit, not the debt. It's a remarkably modest brag. And even so, almost nobody believes him.
There are four ways to deal with a gigantic government debt. One is to live with it. But this is not a stable situation. Even if you're living within your means and borrowing only to cover the interest payments, your debt will compound. When deficits turned into surpluses in the late 1990s, the achievement was especially impressive since it required the government to not just cover its expenses but pick up retroactively a lot of the expenses of the spendthrift '80s.
That is the second way to deal with a soaring national debt: fiscal discipline. The third way is through an economic miracle: an explosion of productivity that increases tax revenues painlessly.
In the late 1990s, fiscal discipline and a booming economy both helped. But you cannot count on another economic miracle like that one. As for the prospect of fiscal discipline: No one looking at the last four years can reasonably expect that from Bush, and it hasn't exactly been a major theme for John Kerry either.
Luckily — or not — there is a fourth way to deal with the national debt. That is inflation. Inflate the debt away. The temptation is enormous: The United States government is a debtor that can borrow any amount of money and pay it back in a currency whose value the debtor contro ls. Other governments are forced to borrow in dollars, not in their own currencies, when lenders start getting suspicious. But Uncle Sam remains preapproved.
In fact, the process is already at work. Inflation is about 3%. So this year we're adding half a trillion dollars to the national debt, but inflation is eroding the real value of that debt by 3% of $4.4 trillion, or let me see (where is that abacus?) $132 billion? Is that right? That's about a quarter of the deficit. Every percentage point of inflation slices the real value of the national debt by $44 billion. At about 11%, inflation starts to reduce the debt faster than we're increasing it. Keep going, and you can wipe it out.
Of course, it's not quite that simple. Inflation affects government revenues and spending in all sorts of ways. Most important is that investors aren't complete idiots. If they know that the government is going to inflate the currency, they will demand higher interest rates to compensate. That is what has been happening lately. But there's a solution: As soon as investors resign themselves to one level of inflation, just ratchet it up to the next level!
So what's the catch? If you have to ask, this shows why inflation tends to happen once a generation. It's been about a generation since the last round in the late 1970s, and many people have forgotten or never knew what it was like.
To start, it is like a tax on anybody living on a fixed income, or any investor with a fixed return. It makes economic transactions difficult and planning impossible. And inflation feeds on itself, as everybody tries to beat it. You cannot have inflation of 11% very long. Either it will soar until the currency is destroyed, or it will be brought painfully back under control.
Then-Federal Reserve Chairman Paul Volcker administered the pain the last time. For almost two decades now, with tremendous skill, Volcker's successor, Alan Greenspan, has preserved that expensive victory without choking off prospe rity (or at least not for very long). On Tuesday, the Fed raised short-term interest rates by a quarter of a percent. On Wednesday, all the experts were saying that's not enough.
But Bush has put Greenspan in a terrible bind. By heedlessly running up the deficit, he has goosed the economy in the short term. And by chipping away at the tax base, he has made it harder to restore fiscal responsibility. There's a drunk at the wheel, and all Greenspan's got is the brake. But he doesn't want to slam it on. Can you blame him?
Using inflation to counteract the effect of his huge deficit is not an explicit part of Bush's economic plan. But shortsighted indifference to inflation is built in. I sorta miss that earlier plan, don't you?