Everyone is going to play numbers games to judge George W. Bush's next economic policies. At the top of the list will be Bush's pledge to cut the budget deficit in half by 2009. Although this promise seems simple, it isn't.
Let's see. Chad Kolton, a spokesman for the Office of Management and Budget, says the pledge was made a year ago, when the projected deficit for 2004 was $521 billion, or 4.5 percent of gross domestic product. Thus, the administration's targets for 2009 are $260 billion, or 2.2 percent of GDP. But wait; the actual deficit for 2004 was $413 billion (3.6 percent of GDP). Should Bush be aiming for half of that? Then there's Social Security. If Bush proposes borrowing to pay for "personal accounts," will those amounts be added to the deficits? They should be, but in Washington, who knows?
All this suggests much confusion and controversy. What's the right target? Who says? Bush may claim he's halving the deficit, while critics say he isn't. But the convoluted arithmetic also holds a broader lesson about Bush's second term. To succeed, Bush needs a strong economy.
Without it the deficits will balloon as the government loses taxes and pays more in benefits. More important, without it, popular discontent -- over jobs, wages, trade -- could combine with opposition to other policies (on Iraq, terrorism, judicial nominations) to weaken Bush's popularity. That would probably doom his ambitious legislative agenda, from Social Security to tax "reform" to immigration. The latest poll from the Pew Research Center shows Bush's vulnerability. By a 50 to 45 percent margin, respondents disapproved of his handling of the economy.
Compared with his first term, you might rate Bush's economic prospects favorably. Recall those first-term problems: a recession, the stock market collapse, corporate scandals and the attacks of Sept. 11, 2001. The White House is now forecasting economic growth of 3.25 percent annually from 2005 through 2010 (on a comparable basis, growth in 2004 was about 4 percent). Unemployment, 5.4 percent in December, will slowly drop to 5.1 percent by late 2006 and stay there. The administration's predictions mirror many private forecasts. "We're shifting to growth of 3 to 3.5 percent a year," says Nariman Behravesh of Global Insight.
Caveats? Well, yes. The forecasts don't allow for the next recession -- and recessions happen. Moreover, some economists dissent. Michael Evans, an independent economic consultant, thinks growth will average between 2 and 3 percent. "I expect stocks to be flat over the next two years," he says.
There's also a small minefield of specific threats:
Oil: Behravesh thinks prices will fall gradually from about $48 a barrel to $37 by early next year. But any unexpected scarcities and higher prices would hurt. He figures that every $10-a-barrel increase shaves half a percentage point off GDP growth.
The Dollar: Massive U.S. trade deficits have caused it to depreciate by about 15 percent since early 2002 against major foreign currencies. Up to a point, that helps U.S. exports; they become cheaper on global markets. The danger is that a continuing drop in the dollar could spill over into stock and bond markets. A falling dollar means foreigners' investments in U.S. stocks and bonds are worth less in their own currencies. They might stop buying U.S. securities or sell. Stock prices could drop or even collapse.
Cheap Credit: It's ending. Since last June the Federal Reserve has raised its overnight Fed funds rate from 1 percent to 2.25 percent. More increases are expected. Although long-term rates on bonds and mortgages haven't yet risen, many economists think they will. By late 2005, Behravesh foresees rates on 30-year mortgages at 6.5 percent, up from today's 5.75 percent. Home construction, housing prices and consumer spending could all weaken.
Greenspan's Replacement: The Fed chairman's term expires in a year. No likely successor will instantly acquire his authority. Any mistakes could shake confidence.
If Bush dodges these and other dangers (a slowdown in China?), critics will still attack his budget deficits. In some ways, this is unfair. True, Bush doesn't plan on ever proposing a balanced budget. But most of his critics aren't any better. (John Kerry also pledged to cut the deficit in half.) Despite Social Security "reform," neither Bush nor Democrats face the spending explosion of the baby boomers' retirement costs. The reason is that the biggest increases stem from health care (i.e., Medicare and Medicaid).
Still, Bush could pay an ironic price for his tolerance of sizable deficits. If the economy falters, it will be harder to apply the classic stimulus -- cutting taxes or increasing spending. The already big deficits will act as a deterrent.