Investors Still Vulnerable to Fiscal Woes

Central banks will have a hard time righting fiscal imbalances.

Jerry Webman
Jerry Webman

I recently attended a conference, the U.S. Monetary Policy Forum, that annually brings together a small group of academic, governmental (especially central bank), and private economists to discuss the current state of monetary policy. Funny thing about this year’s conference: most of the day, including the original research paper that kicked off the meeting, dealt with fiscal policy, or how much we tax and spend, rather than monetary policy—the stuff the Federal Reserve and other central banks actually do. In fact, participants seemed to wonder just how much monetary policy matters when the country seems to bounce from one budgetary crisis to another.

Tellingly, the introductory paper, replete with statistics, complex equations, and more Greek letters than fraternity row, bore the title, “Crunch Time: Fiscal Crises and the Role of Monetary Policy” and concluded, in part, that monetary policy could accomplish very little good if our growing national debt eventually reaches a point where there are no more takers for the government’s bonds. The authors argue that even with federal deficits well down from their 2009 peak and debt consequently growing more slowly, such a “crunch time” could well be approaching.

The Federal Reserve building in Washington, D.C.


Since a room full of economists can’t be expected to agree on much of anything, participants debated the authors’ conclusions, questioning, for example, their reliance on historical data on the experience of small, peripheral European countries. Such countries, the doubters reasonably argued, don’t have the economic strength, the global reserve currency status, or the geopolitical influence that the U.S. enjoys. And the U.S. really has made progress on its fiscal problems, reducing the deficit from 10.5 percent of GDP in 2009 to 7 percent in 2012 and a projected 5.3 percent in fiscal 2013. The debt ceiling compromise in 2011 and the fiscal cliff compromise at the end of last year made more progress than is generally recognized, but no one denied that a serious problem remains. The question is why we don’t do more about it, faster?

We don’t lack for sensible approaches to long-term budget and debt sustainability. One of the day’s speakers was, in fact, Alice Rivlin, who served on Simpson-Bowles commission and continues to advocate its approach to long-term fiscal responsibility. And joining Dr. Rivlin was Professor Martin Feldstein, who offered his own proposal, which I admire greatly for its emphasis on restricting tax expenditures, for increasing revenues and restricting spending. Rivlin, who has served in several Democratic administrations, and Feldstein, who was President Reagan’s chief economic advisor, have in the past differed sharply on policy issues, but at this conference they found very little to disagree about. Their differences appeared to be more about degree than about direction. If we’re really arguing about whether the ratio of spending cuts to revenue increases should be three to one or four to one, why don’t we just split the difference as Rivlin and Feldstein seemed to me to imply? Why do we bounce from budgetary crisis to budgetary crisis rather than just gore everyone’s ox a bit and move on?

The answer is that the debate has moved beyond the mere budget numbers. Budgetary issues, which of course have always been somewhat contentious, provide the context for a much more fundamental political impasse. Today’s real question isn’t about the dollars; it’s about size and role of government. I know that Americans’ math skills have been slipping, but a sudden inability to calculate an average between two amounts isn’t what has polarized government at all levels. A major ideological divide and the mutual ability to block any legislative action are what limit our ability to deal with a budgetary and debt trajectory that almost all observers consider unsustainable.

The budget standoff reflects a division between the view that only by substantially reducing government can we create room for private enterprise to thrive and the view that only continued, even heightened, government intervention can assure that a broadening portion of our citizenry enjoys the opportunity to participate fully in the economy’s benefits. This debate is not a new one but the approaching “crunch time” makes its implications newly difficult to avoid. Although I will repeat that legislation over the past two years has eased the budgetary problem much more than we generally hear reported, I am concerned that our ideological stalemate will keep our incremental policy approach from resolving the very difficult remaining issues.

Fortunately, I’m addressing investors not policymakers in this note, because we can shape our portfolios even if we can’t make our government do the right thing. The first implication is that U.S. government debt may not always remain the supposed safe haven it has seems, especially if its volume relative to the size of our economy continues to grow rapidly. Second, we may find that smaller or refocused government means that the subsidized retirement healthcare, agricultural products, credit, water, insurance, or business investments that we all somewhat enjoy begin to cost more out of our own pockets. I believe if we have sacrificed the opportunity for growth in our investments because we feared loss, we may find that our investments won’t give us the help we need in maintaining our standard of living as all of these costs rise. Ironically, meeting the risk that our political situation creates may mean that we need to consider increasing risk in our investment strategy.

Jerry Webman is the author of MoneyShift: How to Prosper from What You Can't Control and Chief Economist at OppenheimerFunds.