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August 6, 1993
July Non-Farm Payrolls gained 162,000 jobs, right on the slow recovery projection.
Other data support the notion of a persistently weak economy and low inflation. The July Purchasing Managers' Index moved up to 49.5 (the 50 level is break-even for manufacturing), Leading Indicators fell .1% in June, and on Thursday the price of gold collapsed $22 per ounce.
As we go to press, the Senate has not yet voted to pass the budget deal, but we expect that it will. The House gave its ringing endorsement, 218-216.
The savior in the Senate is last minute convert Dennis DeConcini (D., Arizona), who may be remembered by S&L bailout fans as number one of the "Keating Five" who swapped campaign contributions for intervention with regulators. The Senator will probably stay bought this time, too.
The conventional wisdom in the bond market holds that deficit reduction will be a drag on the economy. Any such drag would tend to keep inflation low, and therefore hold interest rates down.
Now, there is an awkward question to be asked. What if it turned out that this budget deal doesn't drag?
No drag? After months of $500 Billion Deficit Cut! blaring from both sides? Biggest tax increase in history! Biggest deficit cut in history!
Heresy: this deal may not slow the economy at all.
First, there are no cuts in current spending, just "decreases in the rate of increase" in 1997-98.
Second, the annual deficit won't change much. The most optimistic White House estimates show today's $300 billion annual hole shrinking to a mere $200 billion five years from now. The deficit is held that "low" by the continuing raid of $100 billion per year from Social Security taxes -- money supposedly being saved for Baby Boomer retirement.
Third, this "monstrous" tax increase is to be $250 billion over five years (assuming nobody changes their behaviour in order to avoid paying the new taxes).
$250 billion over five years is a lot like $50 billion per year. $50 billion in a seven trillion dollar economy is within the range of projection error.
It's a neat trick to raise taxes in the last month of the Bush administration (Bill Clinton wasn't yet President on the effective date of his tax increase), but it won't do much except irritate the payers.
We are not predicting some fast recovery, just questioning the misery quotient of this budget.
However, beyond any political maneuvering, the Fed is predicting a much more rapid recovery. This week David Mullins, Fed Vice Chair, predicted growth beyond 3% in the second half of the year.
If Mr. Mullins is right, the bond market is going to get splattered rather sooner than later.
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