- The Washington Times - Wednesday, January 21, 2004

The $500 billion budget deficits created by President Bush and the Republican-led Congress will be the top economic problem facing the president should he win a second term, Wall Street analysts say.

The twin deficits — the budget deficit and America’s equally large trade gap — already are being blamed for the precipitous fall of the dollar, which has lost between 20 percent and 40 percent of its value against other major currencies in the past two years. And the deficits are starting to put pressure on mortgages and other long-term interest rates.

Mr. Bush’s State of the Union address on Tuesday night offered new spending and tax proposals, but no concrete plans to cut the deficit in half as he has promised to do, continuing the pattern that in recent years has led to exploding deficits.

“The spending spree in Washington continues,” said Sung Won Sohn, chief economist with Wells Fargo & Co., the largest mortgage lender in the United States. “For now, there is no will in Washington to rein in the deficits.”

The current account deficit has jumped in tandem with the budget deficit and reflects “America’s insatiable appetite, including the federal government, for spending,” Mr. Sohn said.

“We are borrowing $1.5 billion from foreigners every single day” to finance the deficits, he said, and that could grow to as much as $2.5 billion in 2005.

“The worry is that a growing portion of the money is coming from unstable sources, including the People’s Bank of China, the second-largest holder of Treasury securities outside the U.S.,” he said. “Unless Washington changes its course, more economic pain will undoubtedly ensue.”

Mr. Sohn is skeptical of Republican arguments that Mr. Bush and Congress suddenly will get religion after the election and tame spending and the deficits. Many on Wall Street think that the free-spending policies and generous tax cuts that have characterized Mr. Bush’s tenure in office have been aimed partly at getting Republicans re-elected and that things could change afterward.

“Some conservatives argue that the administration has long-term plans to tackle the budget deficit” and that they are allowing spending to explode now so as to force deep cuts and reforms in entitlements such as Social Security and Medicare later, Mr. Sohn said.

But there is no evidence of such plans to date, and Mr. Bush is not campaigning on any such dramatic reforms.

Federal Reserve Board Chairman Alan Greenspan has cautioned Congress about the economic consequences of deficit spending.

Mr. Sohn said interest rates on mortgages and other bonds could rise sharply once the realities are understood fully.

Richard DeKaser, a Wall Street forecaster who predicts a comfortable victory for Mr. Bush in the fall, holds out hope that Mr. Bush and Congress will reverse course after the election.

“Don’t be surprised if fiscal austerity emerges on the post-election agenda” of the Bush administration, he said. “Repairing its badly damaged fiscal situation should be its highest priority. Solving the problem won’t be easy, but the longer it’s put off, the more painful it will be.”

“Since the 22nd Amendment to the Constitution forbade a third presidential term, the early part of a second term seems to be when presidents administer the tough love necessary for a favorable legacy,” he said.

Robert E. Rubin, President Clinton’s Treasury secretary now serving as executive committee chairman of Citigroup, said the longer the administration and Congress put off addressing the budget deficit, the more they risk sparking a financial crisis.

The twin deficits already are aggravating foreign investors and contributing to the fall of the dollar, he said. But the financial turmoil seen thus far could look minor if investors lose complete confidence in the government’s ability to control spending and deficits, he said.

“If you get to the point where markets begin to believe the government is going to resort to inflation rather than re-establishing fiscal discipline as a way of dealing with projected long-term deficits, then you have the risk that the markets will start to demand sharply higher interest rates to compensate them for the risk of inflation,” he said.

Such a loss of confidence would have “a severe adverse impact on the economy,” he said.

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