Deficit Attention Disorder: If you believe in Rubinomics, you lost money last week

NRO ^ | 9/4/2002 | Jerry Bowyer

[Utah Girl]

If you read the financial pages last Tuesday, August 27, you probably thought the world was coming to an end. But if you were looking at the smiles on the faces of Democrats, you might have thought the world was undergoing a whole new glorious beginning.

The corporate scandals have played themselves out and American capitalism has survived — in fact, it is arguably stronger and more transparent now than at any time in its history. So what's making Democrats grin and financial writers howl? The deficit of course.

Here's what the deficit hawks are saying: When government runs deficits it must borrow in the capital markets in order to finance its activities. When government borrows from the marketplace it competes with private borrowers, thus increasing demand and causing interest rates to rise. Higher interest rates are bad for business growth because they increase the cost of doing business. Bill Clinton's 1993 tax hike decreased deficits leading to higher economic growth. And George W. Bush's tax cut in 2001 increased deficits leading to lower economic growth.

This argument is popular, sensible sounding, kind of logical, and also completely wrong.

As that great founding statesman, John Adams, once said, "Facts are stubborn things." In this case the deficit-interest-rate-recession theory — most closely associated with former Clinton Treasury Secretary Robert Rubin — has failed to alter those stubborn facts.

On Friday August 29th, the last full business day preceding the writing of this article, the 20-year bond was yielding 5.08%. This means that if the federal government decided to borrow money from the private marketplace (for the longest period of time that it currently borrows — 20 years) the marketplace was charging it 5.08%. Two days before that, on August 27th, the Congressional Budget Office issued the new deficit forecasts which have caused such political mayhem. On that day the yield was 5.20%. This means that the cost of borrowing money declined nearly 2 1/3 percentage points in a matter of only two days. This also means that if somehow last Tuesday you had advance knowledge of the higher-deficit projections, and you used the standard economic methodology of the leadership of the Democratic party, you lost money.

Let me anticipate a counter argument: "Yes, I understand that this week the cost of borrowing decreased, rather than increased as Rubinomics would have predicted, but that's because the markets already knew that the deficits were coming and had already priced the effect of government borrowing into the bond market." Okay, let's look at the day before the signing of the dreaded tax cut: If you woke up on June 7, 2001, just knowing in your bones that Bush would sign his tax cut that very day and that this would cause the emergence of a deficit which would crowd out private spending (yada yada yada) and you bet accordingly, you made a very bad decision because from then to this past Friday the cost of borrowing declined 13.75%.

"Alright," the counter-argument continues, "I see what you mean. But the problem is that by the time Bush signed that tax cut the markets already knew that he would, and priced that information in by then as well."

Okay, then let's go back to the beginning: November 3, 2000. That day, nobody knew for certain what the heck was going to happen. Back then, 20-year bond yields were 6.09%, which means that from the day before Bush was elected to this past Friday the cost of borrowing has declined by 16.58%. There's no getting around these facts. When Bush was elected president the cost of borrowing decreased; when he signed his tax cut, the cost of borrowing decreased more; and when the bureaucrats at CBO sounded the deficit alarm last Tuesday, the cost dropped yet again. Rubinomics fails the data test.

Why? It fails because it was bad theory to begin with. On the surface it makes sense to believe that in a marketplace an increase in demand for something increases the price of it. If the federal government is increasing its demand for borrowed money one would think that that would increase the price (interest) of borrowing money. The problem is that we're not talking about an entire market — were talking about a part of one.

The people who are deciding whether and where to invest their money have many alternatives. They can invest in Treasury bonds, but they can also invest in municipal bonds or corporates or even equities. Not only do they have their choice of U.S. dollar-denominated securities, but they also have British, German, Indonesian, Russian, and frankly a whole world's worth of non-dollar denominated government and non-government debt and equity alternatives. Against this pool of capital, which can be measured in the magnitude of hundreds of trillions of dollars, U.S. deficit financing is infinitesimally small.

If you were hiking through rural Pennsylvania with several of your thirsty friends and you stopped for a moment to pass around your canteen, it would matter to you whether there were five or six in your crowd. One more person drawing water would have a material effect on the supply of the water. But if you were to press on just a little further to the shores of Lake Erie then everybody in the group could drink their fill. And although, theoretically, it would seem as though this would decrease the amount of water in the lake, I wouldn't recommend that you and your friends waste any time sitting on the shore watching the water level decline.

In a healthy and growing economy, capital is like the water in Lake Erie, not the water in a canteen. Its availability should be just about at the end of our list of economic worries. Forget the deficit; focus on growth.

[big bad easter bunny]

Iraq will be all that will gets through for the next 3 months, until we attack. The media is obsessed and Americans never believed those liars in the first place. I am betting it is a slaughter, let me rephrase that, SLAUGHTER! If the liberal message was doing so well, why is know one listening to them? November is there for the taking!