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11/25/92


TITLE #m#ak#m#IS U.S. DEBT REALLY A MONSTER?

No, But It's Another 1980s Myth That Won't Die

Second of two parts Paul Sperry In Houston The horror story of
the federal debt has become something of a legend.

In the first chapter, so the tale goes, a fiendish Ronald Reagan,
like Dr. Frankenstein, creates the monster from scratch.  Chapter
two: The beast devours the economy.

"We will have to live with the deficits built up during the
Reagan era for the rest of our lives," lamented Robert McIntyre,
director of Citizens for Tax Justice, a liberal Washington-based
group.  Now for a reality check.
 Reagan, in eight years, created just 45% of the now $4 trillion
debt.
 Congress exceeded spending requests in all of Reagan's proposed
budgets but one.

Bush's domestic outlays easily overshadowed Reagan's defense
outlays.

Some other tidbits:
 The debt as a percentage of gross domestic product is half its
historic high and is in line with the average rate for the other
G7 industrialized nations.

Historically, big debts have not caused recessions and have not
ushered in high interest rates.
 And, contrary to recent news reports, servicing the debt is the
fourth-largest budget expense - not the first -behind social
security, defense and government services.

In fact, the debt, although certainly not an economic boon, is
relatively benign in its impact, some economists assert.  "The
debt won't blow anybody up," said John Rutledge, a economist and
chairman of Rutledge & Co., a merchant bank in Greenwich, Conn.
"But if you say so, you look like a debt lover." Running deficits
is nothing new to the U.S. economy. In fact, the last time the
federal government posted a surplus was in 1969.  And while the
level of debt is at an all-time high, so is GDP. To get a true
read on the severity of the debt, the two need to be looked at
together. And they often aren't.  As a percentage of GDP, debt
today is less than half what it was in 1946, when the government
borrowed heavily to finance World War II. Then, the debt level
was 127% of GDP.  Yet, even that heavy debt load didn't prevent
the economy from major expansions in the 1950s and 1960s.  Taxes
weren't raised to pay off the debt, and government spending con-
tinued, said Paul Craig Roberts, an economist and chairman of the
Institute for Political Economy in Washington.

Since then, government borrowing and debts have increased con-
sistently, along with the economy. And historically, big deficit
bulges have accompanied major recessions, followed by steady de-
ficit reductions as growth resumed.

For example, in the first recovery year of each of the last three
recessions - 1992, 1983 and 1975 - the deficit as a share of GDP
peaked at 6.5%, 6.3% and 5%, respectively.  IS U.S. DEBT REALLY A
MONSTER?


The deficit then shrank to 1.2% in 1979, just before the 1980
economic downturn, and to 2.9% in 1989, the year before the la-
test recession began. In other words, the economy has historical-
ly grown out from under the debt.  But the notion persists among
pundits that federal red ink hinders growth and threatens econom-
ic security.

Inflation And Interest Rates

The common argument is that higher debts usher in higher interest
rates, which, in turn, curb investment. Economic data don't sup-
port that conclusion.  There is a relationship, however, between
inflation and interest rates. And there is a relationship between
tax increases and interest rates, says Edward Hyman, head of the
International Strategy & Investment Group Inc., a New York
economic research and money management firm.  During the 1960s
and 1970s, he says, rising interest rates went hand in hand with
rising marginal tax rates. And during the 1980s, he notes, in-
terest rates fell as tax rates declined.  During the Carter ad-
ministration, for example, both short- and long-term interest
rates were markedly high, despite relatively low deficits. The
low deficits were due in large part to high inflation drawing
more revenue from taxpayers who "crept up" into higher brackets.
At the same time, the top marginal tax rate was relatively high
at 70%.  Economists across the political spectrum have searched
in vain for evidence to prove the debt is a deadly juggernaut.
Myths regularly have been debunked. Yet hysteria surrounding the
so-called "dark legacy of Reaganomics" has persisted since
Reagan's first term.  "In the end, what will be remembered most
about Reaganomics is the debt that it brought America - towering
mountains of it," the Los Angeles Times reported in a business
story this month.  The debt alarm has been rung before.  In 1981,
before the ink was dry on Reagan's tax-cut proposal, naysayers
were ringing the economy's death knell.


Wall Street Alarmists

Sounding the alarm loudest were two Wall Street economists, Henry
Kaufman of Salomon Brothers Inc. and Albert Wojnilower of First
Boston Corp. The crux of their argument was that tax cuts were
too deep and spending cuts were too shallow, resulting in defi-
cits that would raise interest rates and slow growth.  Even
Reagan's own budget director, David Stockman, later repudiated
the plan for the same reasons, predicting deficits "as far as the
eye could see."

They were right about the deficits. But interest rates came down
and the economy took off. And, despite the massive debt level to-
day, interest rates are still relatively low.  Debt doomsayers,
nevertheless, resurfaced in force in late 1987, after that
October's stock market collapse. This time, it was the "twin
towers" of debt that were casting a long and eerie shadow on the
economy.  Reagan not only had piled high the debt but also had
created a foreign account deficit. The U.S. economy was nothing
but a speculative bubble, pundits mused. And Wall Street finally
popped it in 1987, when the stock market collapsed.  But those
same prognosticators watched the market rally again to new
heights and the economy stay the course.#m##m# More shocking
news: the disinflation trend continued and interest rates held
steady.  Then, once again, the debt became a big issue in the
1990 budget talks. So much so that President Bush and his econom-
ic advisers agreed to a tax-raising, deficit-reduction deal to
bring down long-term interest rates.  While the discount rate has
shrunk to 3% from 7% since the budget deal -the lowest rate since
President Kennedy -long-term rates have stuck above 7%, though
still relatively low and primarily tied to inflation fears.  The
wide spread between short- and long-term rates prompted Kaufman
to get back on his bullhorn last year, echoing old concerns.

Refocusing On Debt


This year, Ross Perot put the debt bug back into unwilling ears.
The independent presidential candidate's message was equally
gloomy and simple: Unfettered deficit-spending is creating a
house of cards that will collapse on future generations.  His
main argument is that government has become too dependent on
foreign creditors, even though most U.S. debt is owned by Ameri-
cans.  Part of the reason the U.S. became a net debtor nation in
1982 is that less investment capital moved out of the nation in
response to Reagan's tax cuts, Roberts explains.  But former
Republican Sen. Warren Rudman, who resigned over the stubborn
debt, concurs with Perot's fears that foreign governments will
one day dictate terms.  "We're getting to the point where the
U.S. Treasury has to go out to borrow another $250 billion and
those who have the money will say, 'Here are the terms and condi-
tions that we're going to set to loan you that money,' " he
warned earlier this year.  Still, others argue, it's highly un-
likely that foreign owners of U.S. debt would pull the plug on
the world's largest consumer market.  At the same time, Perot,
like any good businessman, knows that debts cut into cash flow
that otherwise can be invested in future growth. Financing the
federal debt - which consumes about 13% of the budget - usurps
money that could be better spent on, say, R&D or infrastructure.
But the government is hardly a business.  Unlike a company, the
government can tax to raise money. It also has the power to print
money. So the chances of defaulting on the debt are slim. Be-
sides, the government's debts are only about 23% of the country's
estimated $17 trillion net worth, Rutledge notes.  Then again,
the government borrows money from the private sector to cover the
debt, just like a business. And that "crowds out" private invest-
ment in businesses, which is bad.#m##m# In fact, Federal Reserve
Chairman Alan Greenspan has been quick to point out that although
U.S. debt-GDP ratios compare to other industrialized nations,
private savings have been absorbed at higher margins by govern-
ment deficits.  In Japan, for example, less than 20% of its
private savings has been absorbed by government deficits. In con-
trast, more than half of U.S. savings have been soaked up by to-
tal public debt.

But many critics of Reaganomics erroneously blame the nation's
low savings rate in the 1980s solely on the debt.  One of the
most stinging criticisms about the debt is: Reagan's defense
buildup, which ranks as the biggest spending outside a period of
military mobilization.  Hawks justify the buildup in several
ways.  The military, for one, was dangerously neglected in the
1970s, they argue. Also, conservatives say, the quick, decisive
victories in Grenada, Libya, Panama and Iraq proved the wisdom of
defense investments.  Finally, the hawks say in perhaps their
most compelling argument, the buildup was an opportunity cost. It
forced the cash-strapped Soviets into disarming and, later, into
liberating its client nations. That, in turn, is opening up new
markets for U.S. exports and allowed domestic savings from mili-
tary cutbacks.

Defense Outlays


Those arguments aside, the defense buildup when compared with
economic growth in the 1980s turns out to be relatively minor.
Federal outlays on defense as a percentage of GDP peaked at 6% in
1986, compared with 9% in 1967, according to government figures.
Bush's non-defense spending, by comparison, reached an estimated
17% of GDP in fiscal 1992.  In fact, the Reagan budget deficits
peaked in 1986 while the Bush deficits soared to new heights,
despite roughly $100 billion in defense cuts.

"Defense spending growth ended in 1985," asserted Stephen Moore,
fiscal policy analyst with the Cato Institute. "There's no ques-
tion the explosion in the debt has come from entitlements" under
Bush.  Bush's domestic spending increases, even excluding the
$200 billion savings-and-loan bailout, were still more than seven
times as high as Reagan's and the largest since the Nixon ad-
ministration, Moore says.  Bush, in fact, added about $1.2 tril-
lion, or 30%, to the debt in just four years. Reagan generated
$1.8 trillion of it in eight years, while inheriting roughly $1
trillion from previous administrations.

Budgetary Havoc


A common misnomer, analysts say, is calling Reagan's defense
buildup and his debt one and the same. Actually, debt on his
watch ballooned primarily as a result of the 1980 and 1981-82 re-
cessions, when tax revenues contracted but spending continued to
grow.  Moreover, the baseline calculations for the high inflation
left over from the Carter years wreaked havoc on the government's
budgeting.  Reagan's first budget adjusted expenditure growth to
8% inflation. Prices rose by half that projection, yet money al-
located at higher rates was still spent by Congress.  One posi-
tive aspect of the nation's "debt hangover," as the media often
calls it, is that it "acts as a brake on federal spending,"
Rutledge concluded.

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