Congress: Doomed From the Beginning

Winston Churchill's quip that "you can always count on Americans to do the right thing -- after they've tried everything else," seems especially relevant this week.

The congressional supercommittee tasked with cutting the budget deficit by $1.2 trillion over 10 years has failed. "After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement," the committee announced yesterday.  

Is this surprising? I don't think so. And not because of partisan quarrels -- although those certainly played a role -- but because of what Churchill hinted at: When it comes to fixing the budget, we haven't exhausted all of our options. It's still easy to keep doing the wrong things.

The reason any country needs to keep its deficits in check is that interest rates can rise if lenders question your ability to repay -- sometimes quickly and sharply, stifling the economy.

But that's not happening in the slightest today. While total debt and annual deficits are at all-time highs, interest rates are at all-time lows, and demand at weekly bond auctions has never been higher. The day after America lost its AAA credit rating this summer was one of the best days for Treasuries in history. The bond market is sending an unmistakable message to Washington: Keep the deficits coming; we have an insatiable appetite for every dollar of debt you can issue.

As long as that's the case, Congress will kick the can down the road and put off fixing the deficit. Why wouldn't they? It's analogous to asking people to stop guzzling gas when it costs only $1 a gallon -- rather than change, they'll laugh at you and buy another Hummer. You need urgency to drive change, and right now the bond market is anything but urgent. "Despite the overheated rhetoric in Washington, the markets are giving us plenty of space," Washington Post columnist Ezra Klein wrote yesterday. "So though deficits will eventually prove a problem, they're not our most pressing concern."

It hasn't always worked this way. Consider this 1992 quote from the Los Angeles Times: "There will be serious constraints on the policy options of the President of the United States in 1993 -- and it doesn't matter what his name is." Another news account summed up why after President Clinton won the election:

Bill Clinton's economic stimulus plan may have won a good reception from voters, but it faces a more difficult -- perhaps fatal -- test at the hands of a powerful counterforce: the bond market. If the president-elect moves to jump-start the economy by sharply increasing government spending, the bond market is likely to react negatively by jacking up yields and raising the cost of government borrowing.

Which is exactly what happened. In 1993, 10-year Treasury bonds yielded 5.3%. By 1994, the yield had surged to over 8%, in part likely due to worries that a continuation of the huge deficits of the previous decade would spark inflation. As Clinton advisor James Carville famously said, "I used to think if there was reincarnation, I wanted to come back as the president or the pope. But now I want to come back as the bond market. You can intimidate everybody."

He wasn't kidding. It was widely accepted at the time that the bond market dictated the direction of the economy. "More than any other group, the bond market's members determine how many Americans will have jobs, whether the jobholders will earn enough to afford a house or a car, or whether a factory might have to lay off workers," wrote The New York Times in 1994.

But the same bond investors who seemingly held the keys to the economy helped move public policy to a safer, more sustainable path. The basis of all economic policy in the mid- to late 1990s was that the economy would only boom once long-term interest rates came down, and the best way to bring them down was to balance the budget. It wasn't complicated: Spending had to be restrained, taxes had to be raised -- both parties compromised -- the bond market would be appeased, and economic growth would take off.

By most measures, it worked. By 1999, government spending as a percentage of GDP was at a 35-year low, taxes as a percentage of GDP were at a 50-year high, the budget was in surplus, long-term interest rates had declined, and the economy was booming. You can never chalk up the state of an economy to one specific thing, but the fiscal policies of the mid- to late 1990s -- dubbed Rubinomics after then Treasury Secretary Robert Rubin -- are by and large thought to have helped fuel that period's economic boom. And they may have never happened unless the bond market forced Washington to act through higher interest rates in the early 1990s.

Today, there's no heavy hand forcing, or even encouraging, Congress to act. In part because deleveraging has sparked fears of deflation, and in part because other parts of the world are in far worse shape than America, our interest rates have never been lower. The impact this has on the economy is massive. The interest cost on the national debt was lower in 2009 than it was in 1991, even though the amount of debt was more than twice as high. The percentage of small businesses claiming interest rates are their largest problem was recently 4%, near the lowest it's ever been, according to the National Federation of Independent Businesses. A 30-year mortgage now carries an interest rate of 4.07%, down from 6.5% in 2008. America has plenty of problems, but high interest rates aren't one of them. Yet.

Once interest rates do rise, the amount of debt accumulated during these years of generous bond markets comes home to roost. The average yield on Treasury debt this year is around 2%. With $10.3 trillion in public debt outstanding, every 1% rise in interest rates adds $103 billion a year to federal spending -- or about what we spend annually on education.

Moving to an average cost of debt closer to 6% (where it was in the early 1990s) would balloon federal spending by nearly half a trillion dollars a year, or roughly what we spend annually on Medicare. Deficit spending is almost certainly necessary to help the economy recover from recession, but the easier it is to accumulate cheap debt today, the more dangerous it becomes tomorrow. It's the classic giving-us-enough-rope-to-hang-ourselves-with situation.

What's the solution? I asked former U.S. Comptroller General David Walker. "Low interest rates provide a false sense of security and interest rates could change quickly in the future," he said. A heave in the bond market might inspire Washington to act, but why wait? Providing Congress with the right incentives is up to you, he says. "If 'We the People' put pressure on Congress to act and make the political price of doing nothing greater than the political price of making some tough choices today, [we can] help create a better tomorrow."

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 22, 2011, at 2:54 PM, HighVoltage627 wrote:

    I cant help but find it disappointing that a proverbial gun has to held to the head of congress to get them to compromise, whether it be voters, or the bond market, or whatever. Politics shoudlnt trump national interest. I get more disheartened by the day.

  • Report this Comment On November 22, 2011, at 3:03 PM, TheDumbMoney wrote:

    All of this makes one wonder why the Treasury has actually lowered the average duration of our debt during the last ten-to-fifteen years (if my memory is correct). A lot of the risk of future higher rates could be removed if the Treasury focused on 30-year bonds at this time, and if we could thus raise the average age-to-maturity of our national debt.

  • Report this Comment On November 22, 2011, at 3:41 PM, DJDynamicNC wrote:

    Some interesting points about the "failure" that we're all hearing about:

    1) This failure to agree on specific cuts only means that other, different cuts go into effect; we're still going to trim 1.2 trillion from the budget, largely in the defense budget. This will cause the defense budget to drop sharply... all the way down to where it was in 2007. Was our military crippled in 2007? If not, then we'll be fine in 2012 too.

    2) The "supercongress" missing its deadline of Nov. 23rd does NOT dissolve the "supercongress." All it does is remove their power to shield their proposal from filibuster and amendment. By law, the "supercongress" still has a responsibility to meet and attempt to come to a resolution until January. Why aren't they? Could it be that this was all an unserious exercise in grandstanding all along?

    3) Perhaps our best bet for closing the deficit is simply letting Congress do nothing - which they excel at - and allowing the Bush revenue cuts to expire.

    4) There is no possibility of a US default so long as we avoid arbitrary limits like the (possibly unconstitutional) debt ceiling. The US prints its own currency. Paying our bills is that simple. Would rampant inflation be bad? Obviously, yes. Would we necessarily face rampant inflation in the event of releasing additional money into circulation? Since we'd only really be making up for the money that was destroyed in the 2008 crash, I have my doubts (banks, after all, can simply wish several more dollars into the economy for every one dollar they receive, through the magic of leverage). So I wouldn't be quite so concerned about "hanging ourselves."

  • Report this Comment On November 22, 2011, at 3:43 PM, slpmn wrote:

    I thought interest rates increased in 1994 not because of the invisible hand of the bond market, but because of the gnarled hand of Alan Greenspan. Correct me if I'm wrong.

    If the bond market was worried about the fundamentals, it would be reflected in US debt rates, which are at historical lows. The only people actually worried about American debt levels are fiscally conservative members of the public, who feel its "just wrong" to have so much debt. Republicans don't actually care. Democrats don't either.

    Although I count myself among the fiscally conservative who think its "just wrong" to have so much debt, I have yet to hear a rational argument for why a recession is the time to enact massive spending cuts.

    Let's give the economy some time to come back and see what kind of revenue a healthy economy can generate under the current tax code, without two wars to pay for. Who knows, we might break even.

  • Report this Comment On November 22, 2011, at 3:46 PM, ironhide196 wrote:

    Are they seriously wishing for social unrest?

  • Report this Comment On November 22, 2011, at 3:51 PM, DJDynamicNC wrote:

    @slpmn: +1 to that entire post.

  • Report this Comment On November 22, 2011, at 4:26 PM, TMFDarwood11 wrote:

    I think congress and the rest of government is gambling. Gambling that interest rates will remain low. And it should until at least the 2012 election. That is all that matters to the President and many members of Congress.

    However, they're not alone. People are flocking to buy US Treasuries. It's a big gamble. The assumption is, inflation won't rear it's ugly head for 6-10 years.

    This from the same people who flocked into real estate, and the same congress which primed the pump with policy facilitated by the Fed.

    Should I trust any of these people? I'm feeding the idiots who did, and participated in the most recent gambles.

    This will end badly, The only question is, just how badly, and when. My guess is, it will end sooner than later.

    Yes, we are different than Europe and in particular, Greece. However, the bond market can shift rapidly, and when confidence is lost, or a better opportunity arrives, I suspect people will be shocked at how rapidly things change.

    For the moment, it is assumed the short term $15 trillion debt hole can be dealt with. It is assumed that our government will back our bonds and not inflate ourselves out of this mess. It is also assumed that our bonds will continue to provide a better yield at lower risk than the competitors.

    None of the above are true, as in guaranteed. It is also likely that inflation will occur.

    Frankly, I trust certain large corporations at this point to do a better job than the US government, and that's where I'm putting my money. Why do I have money to invest? Because I avoided the housing fiasco and did not mortgage my life, because I've avoided putting all of my spare cash into "safe" US government debt. Etc. etc.

    What surprises me is, most of those who argue that "everything is fine" seem to ignore the rising cost of health care, and the impact on government spending. Finances will get worse. This isn't Europe with relatively stable health care costs, aside from the addition of aging population. The US has a government financed health care bubble and a growing aged population.

  • Report this Comment On November 22, 2011, at 5:02 PM, DividendsBoom wrote:

    GDP = amount spent every year. GDP does not care who is spending or where it came from, cutting spending would lower GDP possibly triggering a GDP recession. Can't have that, must keep borrowing to spend.

  • Report this Comment On November 22, 2011, at 5:33 PM, xetn wrote:

    Two Points:

    It is completely stupid to think that a group of Dems/Reps could agree on anything, much less "decide what is best to cut". The problem is none of them want to cut anything. We really need to just cut congress.

    The second point is GDP is a very bad representation of economic activity because of the governments role in it. What ever government spends is taken from the private sector, a cut off-the top is taken for "handling" and the rest is spent with more "handling charges" at each level. It is mostly just waste.

  • Report this Comment On November 22, 2011, at 8:29 PM, artheen wrote:

    The interest rates in the US are low because the other "big consumer of money", Europe, is more of a risk than the US. So the best place to park the "cash" generated by higher saving economies tilts in favour of the $.

  • Report this Comment On November 22, 2011, at 8:40 PM, artheen wrote:

    The US debt though is a different animal. It is function of "cheap money" being made available by the FED (because it can, arguing they must, otherwise unemployment would trend higher 20ish% like Spain), the people who are borrowing because can, the Govt itself is not ready to cut "essential" services and the congress wont allow raising taxes.

    Its a problem only one American, Houdini, could have solved but alas he is dead!

  • Report this Comment On November 22, 2011, at 9:57 PM, irvingfisher wrote:

    This "failure" will trigger automatic tax increases and spending cuts. All is unfolding exactly according to plan: the republicans can blame the democrats for the automatic tax hikes, and the democrats can blame the republicans for the automatic spending cuts.

    The original deal setting up this committee simply removed the need for congress and the senate to vote in favor of necessary measures they didn't like. Now they can say they didn't vote for those measures, but they'll go through anyway.

    Seems like a big success to me. Maybe I'm missing something.

  • Report this Comment On November 22, 2011, at 10:03 PM, cmfhousel wrote:

    <This "failure" will trigger automatic tax increases and spending cuts.This "failure" will trigger automatic tax increases and spending cuts.>

    There are no automatic tax increases as part of the sequester. The 2001/2003 tax cuts are scheduled to expire in 2013, but that's a separate issue from the supercommittee's mission, which was laid out during the debt-ceiling deal this summer.

  • Report this Comment On November 22, 2011, at 10:28 PM, MaxTheTerrible wrote:


    I have the same feeling that the automatic cuts were preferred by Congress from the start, but since no politician in their right mind would vote for something like that, a failed supercommittee is a win-win for everyone (except those affected by the cuts, of course).

  • Report this Comment On November 22, 2011, at 10:54 PM, CaptainWidget wrote:

    <<4) There is no possibility of a US default so long as we avoid arbitrary limits like the (possibly unconstitutional) debt ceiling. The US prints its own currency. Paying our bills is that simple. Would rampant inflation be bad? Obviously, yes. Would we necessarily face rampant inflation in the event of releasing additional money into circulation? Since we'd only really be making up for the money that was destroyed in the 2008 crash, I have my doubts (banks, after all, can simply wish several more dollars into the economy for every one dollar they receive, through the magic of leverage). So I wouldn't be quite so concerned about "hanging ourselves.">>

    Default simply means failure to fulfill an obligation. The US can avoid defaulting on the monetary figure on a bond by inflating the dollar, but then they default on the obligation of fulfilling the value of the bond. Either way, it's still a default. This argument that the government is incapable of a default because we're simply hyperinflate our money supply is absurd.

    It will still be a default in the eyes of the market, who will realize the VALUE has been defaulted on and then stop buying US bonds.

    The idea that it won't be hyperinflation because we're only replacing money lost during the last period of hyperinflation.....ugh...........

    Inflation is not hard, and it's not advantageous. Suggesting it in any circumstances is asinine.

  • Report this Comment On November 23, 2011, at 12:26 AM, 4evergolfing wrote:

    I heard this on TV:

    "Congress never misses an opportunity to miss an opportunity."

  • Report this Comment On November 23, 2011, at 9:13 AM, SwampBull wrote:

    Congress and the President will continue to try to goose the economy with federal spending...

    Until either they fracture their wrist, or strangle the goose dead.

  • Report this Comment On November 23, 2011, at 2:06 PM, TheMotleyTimbear wrote:

    Housel for Congress

  • Report this Comment On November 25, 2011, at 12:28 PM, DJDynamicNC wrote:

    @CaptainWidget "It will still be a default in the eyes of the market, who will realize the VALUE has been defaulted on and then stop buying US bonds. "

    Yes, you are correct that if you change the meaning of the word "default" to whatever you want it to be, then you can somehow contrive to make paying one's debts in full in the currency in which those debts are denominated still somehow a default in the magical eyes of the all seeing market.

    By your reasoning, if I pay the last payment of a 30 year mortgage in dollars which are worth less than the dollars with which the agreement was initially negotiated, I have magically defaulted in the eyes of the market.

    I would have trouble squaring that line of logic with empirical reality, and I suspect you will too.

    I'm also still awaiting the looming hyperinflation we've been hearing was "just around the corner" or "already happening" for the last three years.

    And because I recognize how these things work, let me give you the same argument but coming from a respected conservative:

    And I could lose my liberal card for intentionally linking to the National Review, so please at least read through it and tell me what you think so the sacrifice was worth it. :lol:

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