Outlook: US economy

AS ONE US Treasury official noted yesterday in announcing plans to buy back US government bonds, the years 1998-99 mark the first time the federal government has boasted back to back budget surpluses since 1956-57. There will be a record reduction in the national debt this fiscal year. If all goes to plan, the debt will be eliminated by 2015.

Not surprisingly, the prospect brought some relief to the troubled US bond market, bringing down the yield on the benchmark 30 year bond. The short term woes will return, however. The US economy is at that stage of the business cycle where growth will weaken and inflation will pick up. This will be reflected in yields despite the likely shortage of supply.

In the longer run, however, the staggering improvement in the US government's finances is of huge importance and benefit to the economy. Most obviously, the less interest the government has to pay, the more money it has to spend on education, health and bridges. A fall of 3 basis points in its cost of borrowing frees $1bn a year of government expenditure.

Indirectly, lower bond yields also mean lower borrowing costs for businesses and households. In fact, the length and strength of the US economic expansion are closely related to the Clinton Administration's early and determined efforts to cut the massive deficits inherited from Presidents Reagan and Bush.

Many Democratic activists resented the demands of fiscal orthodoxy at the time, as it meant giving up hopes of expanding spending programmes. James Carville, the tough Clinton election adviser, famously said that if he wanted real power he'd like to be reincarnated as the bond market. This was just about the time Alan Greenspan persuaded Clinton it was worth giving up on the spending for the sake of the reduction in long-term interest rates.

The result has been the second longest expansion on record, likely to turn into the longest next January. Never mind the technological revolution and the stock market. Deficit reduction has been the secret ingredient in America's economic miracle. Debt reduction could well sustain it. The US has set an example of the benefits of financial orthodoxy which some European governments, whose budget plans one analyst described yesterday as "quantified escapism", would do well to copy.

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