Debt-free zone: a new American dream

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The Independent Online
IT WAS an advert on American TV last week that made me realise that something big might be happening to the US budget. It showed a young professional woman, middle 20s, and, as she explained, in her first job. She was appalled at the amount of tax that was being deducted from her pay check - but this was not a political advert calling for lower taxes as such. No, what appalled her was the amount of money she as a wage-earner was having to pay on the interest on Federal debt: $800 a year on her calculation. If the government went on borrowing at this rate, it would have no money left to help her in her old age. The answer was to balance the budget: "Do it now."

Well, a TV ad is a TV ad and nothing more. It shows that the balanced budget lobby in the US has some money behind it; it also shows, however, that this lobby has identified intergenerational equity - fairness between generations - as a pow- erful argument in favour of its goal. It is, in effect, asserting that "government borrowing is merely postponement of taxes" and therefore damages the interests of future generations of taxpayers.

This second quote, however, comes not from a TV advert but from a new report Savings, Investment and Real Interest Rates. This was prepared for the Group of Ten - the main developed countries - by a committee chaired by Mervyn King, head of the economic side of the Bank of England. The theme of the report was that governments around the world had to cut their budget deficits. Real interest rates were unusually high at the moment - about 4 per cent - because of an imbalance between savings and investment, and the large government deficits were the main culprit.

This relationship noted by the G10 certainly seems to work for the US. HSBC Markets spotted this: as their graph shows, when the budget deficit was at its greatest in the early 1980s, the real interest rate on the US government's long-term debt was at its highest. It is not an exact "fit" by any means, but it is not a bad one.

The G10 report was accepted by the various goverments, so on paper at least, the argument it makes is also accepted. It is certainly the formal British position that the budget should be balanced over the medium-term, though the hints of tax cuts given by Kenneth Clarke at the Tory conference last week suggest that the medium-term is a little way off.

In the US, by contrast, it looks rather closer. The other graph shows Goldman Sachs' projected budget deficits for 1996 for the seven summit countries. America is doing really rather well, with Canada and the UK not too bad either. The rest of the graph speaks for itself. To be sure, the US, Canada and the UK are at a different stage of the economic cycle from the rest: they are further into an expansion. It is true, too, that private-sector savings on the Continent and particularly in Japan are higher than in North America or Britain, and so these countries are better able to finance budget deficits. Nevertheless, the plain fact remains that in relative terms the US has become a model of fiscal probity.

It is also the only country where the need to balance the budget is a subject of hot political debate. This debate comes to its climax in the next four weeks. Both President Clinton and the two houses of Congress, dominated by the Republicans, have plans that would eventually eliminate the deficit. But no deal has been reached in Congress and plans have to be on the President's desk by 13 November. It is expected that he will then use his veto, and the budget will have to be re-submitted.

The wrangle is then expected to continue until Christmas. There is, however, a problem. The legal limit on the size of the US national debt will be breached in mid-November, giving rise to fears that the US might default on its interest payments which then become due. The Republicans say they will not increase the debt limit until their plan for a balanced budget is accepted. In fact there are various ways the US Treasury can scrounge more cash for a month or two, and this impasse has happened before. Nevertheless, the debt ceiling gives an obvious and powerful lever to the Republicans.

The detail of all this is pretty tedious for the rest of the world, but the big picture is fascinating. There is a giant chasm between the ways in which President Clinton has been seeking to cut the deficit and the various plans of the Republicans. He has been prepared to increase taxes and hold spending, while their response is to cut taxation - mainly for the rich - but cut spending even further. There is a wide gap, too, on the timescale over which the budget should be balanced. But what is almost beyond dispute is that the deficit will come on down. Even cynics believe that it could be below $100bn (pounds 66bn) in seven years' time - last year it was about $170bn. That would mean a deficit of only about 1 per cent of GDP.

Imagine the impact on the rest of the world. You do not need to believe that American political ideas will find root elsewhere to see the effect a fiscally responsible America would have on the rest of us. Money is more mobile internationally than ever before. Even if other countries did not buy the political case for a balanced budget, they would be under pressure from the markets to buy the practical one.

If the relationship holds between real interest rates and the US budget deficit, America could have the lowest real interest rates in the world with all the benefits to growth that cheap money would help generate. More likely, other countries would be forced to compete by cutting their deficits, too. The balanced budget could become the main internationally exported economic idea of the late 1990s. Look at the way earlier ideas such as cutting top income tax rates, privatisation and giving greater independence to central banks have swept the world.

It will also change the political balance between the large, developed nations. The US economy remains, of course, the largest, but the intellectual leadership of the US has been balanced by the economic success of Japan and Germany. Now both those apparently successful economies seem a little tarnished, while for all its faults, the US economy has performed very well in the last seven or eight years. Now add fiscal probity. It would certainly be a change for US Treasury officals to be able to lecture the rest of the world from a position of real fiscal strength. Expect that to change the balance of authority, the intellectual leverage that America has on other countries.

It is impossible to predict the pace at which the US will export the idea of a balanced budget. It is still some way from achieving it itself. Most Republicans would in any case see a balanced budget as merely a staging post on the way to a more radical rolling-back of the state, a view of the world which at the moment is hardly echoed at all outside the US. By US standards, the echo here is pretty muted. But what is surely beyond dispute is that the next few weeks will tell us a lot not only about the American fiscal position, but the direction our own fiscal policy - and that of continental Europe, and of Japan - will have to head for perhaps a decade to come.

The faster the Americans race to the balanced budget, the faster we will tag along. And we will not have to wait for the first party political broadcast calling for a balanced budget to know the game is up.

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