Forecasting the great crash of '98

March 07, 1995|By R. Taggart Murphy

Tokyo -- IF THE REPUBLICANS sweep the 1996 elections, adding the White House to their control of Capitol Hill, their triumph may be very short-lived. For there will be no Democrats to blame when the day of reckoning for America's fiscal mess arrives in the late 1990s.

Compound interest -- interest on money borrowed to pay interest on yesterday's debts -- will be the reason for the mess. The United States has been using it for two decades. But as you know if you have ever juggled credit cards to postpone going broke, the interest can run away from you.

There are three components of the federal budget that really matter -- military spending, Medicare and interest on the national debt. In addition, Social Security, technically not part of the budget, is central to it. The rest is small change, relatively speaking.

The Democrats and the Republicans are playing a game of political chicken to force each other into blurting out the truth -- that unless taxes rise or Social Security and Medicare payments are cut, the country will face catastrophe.

The president played chicken in his State of the Union message by offering tax cuts and increases in military spending, while pledging to protect Social Security and Medicare.

The Republicans played chicken with the balanced budget amendment. It let them preen as deficit-cutters while buying votes with the Contract with America, which remains a deficit-increasing program.

We saw all this before, in 1981. The Reagan administration got the tax cuts it wanted, expecting that fear of financial catastrophe would force Congress to enact comparable spending cuts. But Speaker Thomas P. O'Neill Jr. was not about to save the administration's hide. He waited for the White House to make the first small noises about cutting Social Security, then pounced. Wounded, the Reaganites retreated. Neither party would move. America was on the road to a $4 trillion national debt.

The only catastrophes so far have been political, visited on those who tried to roll back the deficit: Walter F. Mondale's 1984 pledge to raise taxes. George Bush's 1990 retreat from "Read my lips: no new taxes." Bill Clinton's decision as president-elect to tackle the deficit before "investing in America."

The Republicans hope 1981 can be repeated. It can't. That confrontation ended without a crash because the Japanese largely financed the explosion in deficit spending. But they cannot finance a second explosion: The situation has changed too much.

In 1981, dollar interest rates were high. Today, they are comparatively low. Then, Japanese companies had a lot of extra cash. Today, they face a cash crunch. Then, everyone assumed the dollar could never be worth less than 180 yen. Early yesterday, the dollar plunged to another record low of 93.23 yen. On Friday, it closed at 94.14 -- despite joint interventions by the Federal Reserve, Bank of Japan and European central banks.

Because of the dollar's weakness since 1985, Japanese life insurance companies alone have lost some hundred billion dollars. They're wary about being conned into loading up again on 30-year bonds issued by an American government that has repeatedly trashed its own currency.

True, the Japanese are no longer big players in the U.S. government securities market. But they are running the largest trade surplus of any country in history -- about $140 billion in 1994. Since most it is denominated in dollars, most of it ends up back in the United States.

There are two crucial differences between today's dollar recycling and that of the early 1980s. Back then, the surplus dollars went mostly into long bonds -- 30-year Treasury securities -- and other investments of comparable maturity. Today, the money is going into the shortest and most sensitive of financial instruments -- for example, short-term lending to American banks.

A decade ago, the dollars that Japanese exporters earned were put directly into Treasury bonds or other long-term investments. Now, with exporters facing a dwindling cash flow, the dollars first go through the Bank of Japan, which exchanges them for yen. The Bank of Japan then sells the dollars to Japanese banks, which lend them back to the Americans.

This means that the Japanese monetary authorities stand between the Japanese exporters earning the dollars and the banks investing them. As a result, to quote Akio Mikuni, who runs Japan's only independent credit rating agency, "the funding of the U.S. deficits is now hostage to Japan's monetary policy."

Washington should heed Mr. Mikuni: He is a thorn in the side of the Japanese establishment and has been more consistently right than anyone else in his predictions of the fallout from the bursting of Japan's "bubble" economy of the late '80s. But his analysis would chill the Republican National Committee.

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