EVEN if the Gulf war proves to be short and decisive, Washington will still face a daunting task in paying the bill. Without fighting in the Middle East, the Treasury deficit would have approached $300 billion this year. Under present circumstances, it could be much higher. Before investors run for shelter, however, they should take a closer look. The red ink now flooding out of the Treasury appears less threatening to the economy than many analysts now assume.
First, United States allies will pick up much of the war tab. Second, the Budget Enforcement Act of 1990, a key result of the marathon debate over fiscal policy last fall, represented a serious attempt to put a lid on federal spending. Third, detailed analysis suggests that the impact of the deficit may be relatively benign.
The new rules to control federal spending are complicated. While complexity is not necessarily a virtue, many analysts believe the new procedures will be much more effective than the rubbery spending ceilings under the old Gramm-Rudman-Hollings Balanced Budget Act.
Congress designed the complex requirements of the Budget Enforcement Act to close loopholes under the old law. Members will now have to make genuine choices between competing demands for funding. Among other conditions, the law set two broad groups of programs: discretionary appropriations, which Congress must vote every year, and so-called direct or entitlement outlays, governed by more permanent laws.
The law created three classes of discretionary spending - defense, international, and domestic. It then set separate spending caps for each type. Congress will trigger an automatic sequester (mandatory cutback in spending) anytime it passes a law that will breach the outlay ceiling for a particular category.
In addition, there are ``pay-as-you-go'' sequesters to control both revenues and expenses of some of the major entitlement programs such as Medicaid, unemployment insurance, revenue sharing with the states, and federal retirement benefits. Over time, if the net effect of these programs were to increase the deficit, a sequester would reduce outlays by a uniform percentage sufficient to put the budget back on target.
As a third line of defense, Congress left in place the basic revenue and spending controls from the old Gramm-Rudman act. If the overall deficit appears likely to exceed specified targets, then across-the-board cuts will follow. Half will come from defense and half from ``nonexempt,'' nondefense sectors.
The new rules are far from perfect. In general, Social Security and interest on the debt remain outside the budget control process. No one will go to jail for simply ignoring the rules. Nevertheless, the attempt was serious. Moreover, three times in each annual budget cycle, members of congress will have to tote up the sums to see where they stand in relation to their budget targets.
Meanwhile, interest rates are down (and bond prices up) despite the certainty of massive Treasury borrowing. In part, this is simply a result of the recession and the likelihood that inflation will slow to a crawl in 1991. Bond buyers have several other reasons to be optimistic:
Except for the Treasury, demand for credit has fallen through the floor. Total nonfinancial, nonfederal debt came to $7.9 trillion in November, up only 5.5 percent from a year earlier. Except for a brief period at the bottom of the 1973-75 recession, that was the slowest rate of increase in private debt since the figures were first collected in 1955. This means that there is plenty of room in the credit markets for Uncle Sam.
Much of the increase in federal outlays in the past year is to bail out millions of savings and loan depositors across the country. As Commerce Department economists concluded more than a year ago, these transactions are ``asset transfers'' rather than outlays for goods and services. As a result, borrowing to bail out S&L depositors will have little or no impact on the net need for credit. The Treasury's demand for credit is offset by the funds it supplies to depositors of failed S&Ls.
Through the third quarter of last year the remaining Treasury deficit was accounted for by interest on the $2.5 trillion federal debt. Interest payments also involve dollar-swapping. The Treasury is a conduit - taking funds in and paying them out, sometimes to the same investor. Such borrowing does not add to Washington's net demand for credit.
In fact, the basic federal budget - revenues less outlays for goods, services and transfers other than interest - was in balance last summer. This is typical of the early stage of a business downturn. That won't be true later on this year, but even so the basic federal deficit should be modest. Interest rates usually drop during recessions. The 1990-91 recession should be no exception.