Eight months into his presidency, Ronald Reagan faces a growing skepticism that Reaganomics will produce a healthy, growing, noninflationary economy.
News about sky-high interest rates and the potential for triple-digit federal budget deficits have shoved the good news about inflation and the lack of bad news on unemployment out of the headlines. Instead of expressing pleasure about the coming higher after-tax returns on investments, financial analysts complain about the coming after-the-tax-cut budget deficits.
Like a fever, high interest rates are a symptom that something is seriously wrong in the nation's economy. If they climb too high, they can kill. Homebuilders and buyers, farmers, small businessmen and thrift institutions, among others, are bearing the brunt of the tight-money siege. They are part of the ever-widening group questioning whether and when Reaganomics will work.
Reagan is reported to be frustrated and annoyed. He has delivered the equivalent of back-to-back miracles on Capitol Hill by persuading Congress to accept largely intact his budget and tax cuts. Inflation, courtesy of falling oil prices, has dropped faster than anyone expected. And unemployment, courtesy of falling productivity, has not worsened even in the midst of what some economists regard as a recession.
All the carping and complaining has so far only caused Reagan to dig in his heels and push to find new ways to cut the federal budget. He refused to follow the counsel of some of his advisers and admit that the 1982 budget deficit -- even after the $16 billion worth of additional spending cuts to be announced this week -- will be well above $42.5 billion. He has been equally unwilling to acknowledge that continued high interest rates may easily delay the expected economic recovery well into 1982.
In an effort to underscore how steadfast his policies are, the president has attacked his critics and denied their arithmetic. On some occasions, such as on the South Lawn of the White House last week, when Reagan told a group of about 1,000 businessmen that his programs would not begin until Oct. 1, he seemed to have forgotten some of the parts of Reaganomics:
* The most important element in the four-part program the president proposed last February, a highly restrictive monetary policy, was in place even before he took office.
* The tax cuts for business, as requested, were made retroactive to Jan. 1.
* Businesses are already getting considerable relief from federal regulatory burdens, administration officials themselves maintain.
* Significant cuts began last spring in some major federal spending programs, such as public-service employment under the Comprehensive Employment and Training Act.
Moreover, Reagan, in seeking to convince the nation he intends to stick with his policies, glosses over the fact that those policies already have changed substantially. For instance, Oct.1 originally had no meaning in Reaganomics except as the beginning of a fiscal year.
When Reagan was campaigning a year ago, he promised he would hit the ground running with a massive program of spending and tax cuts that were to begin Jan. 1. After the election Reagan's advisers persuaded him to postpone the first of three 10 percent personal income tax cuts until July 1, to hold down the 1981 budget deficit. Then the Reagan timetable slipped again, with the first personal tax cut halved and put off until the middle of next week, and the eventual total tax reduction trimmed from 30 percent to 25 percent.
The essence of the current Reagan appeal is that everyone should pretend that what has happened economically so far this year is not relevant to judging the likely results of Reaganomics.
That is the course the president took in rejecting the appeal of David Stockman, director of the Office of Management and Budget, for significant reductions in the huge projected increases in defense spending over the next three years. Reagan agreed to reduce the increases by only $2 billion in fiscal 1982, by $5 billion in 1983 and $6 billion in 1984.
Similarly, the present, hurried 1982 budget-cutting exercise -- f it should achieve $16 billion worth of cuts, including the $2 billion from defense -- would only fulfillment of a set of reductions the administration has been counting on making all along. The Congressional Budget Office, with an economic forecast only slightly less optimistic than that of the administration, expects a budget deficit of about $65 billion even if cuts of that magnitude are made.
CBO director Alice Rivlin and Federal Reserve Chairman Paul A. Volcker both told congressional committees recently that spending cuts -- or tax increases -- on the order of $100 billion are needed to balance the budget in 1984, as Reagan has promised.
A memo from Senate Budget Committee chairman Pete V. Domenici (R-N.M.) to Majority Leader Howard Baker (R-Tenn.) in late August indicated that the administration's own estimates of the potential 1984 deficit were equally high. Stockman's "latest guess," Domenici said, was that the '84 deficit would be $78 billion, assuming more than $20 billion worth of cuts specifically proposed by the administration -- including some major Social Security benefit reductions unanimously rejected by the Senate. Unlike the figures released in the administration's mid-session budget review in July, Stockman's number included no allowance for what was labeled "savings not yet proposed."
The size of the deficit has become so critical because of the central dilemma of Reaganomics: monetary and fiscal policy are set on opposite courses.
Reagan and his advisers recognized that fact when they chose to reduce and delay the personal income tax cuts earlier this year. Their new scramble to cut spending is a further acknowledgement of the dilemma. Cutting the budget deeply enough would resolve the inherent conflict, but with defense spending still slated to rise rapidly in real terms for years to come, many observers doubt the president can slash outlays that much -- his initial successes notwithstanding.
Meanwhile, as Fed chairman Volcker noted last week, to finance its deficit the federal government is taking half of all the nation's savings other than that needed just to replace businesses' worn-out plants and equipment and to hold the supply of housing constant. In the final three months of this year, for instance, the Treasury will have to raise about $33 billion of new money, the largest amount ever.
Volcker left no doubts that the Federal Reserve, with the administration's full backing, intends to continue to fight inflation by steadily reducing growth of the money supply. The Fed tentatively has set a goal for money growth during 1982 of about 4 percent for M1-B, the measure of money that includes currency in circulation and checking deposits at financial institutions. Usually, the economy can also count on about a 3 percent rise in the velocity of money -- the rate at which each dollar moves through successive transactions.
Taking those two figures together means there probably will be enough money around to support about a 7 percent increase in nominal incomes next year, but most forecasts, including the administration's, show prices rising more than 6 percent, perhaps more than 7 percent. In other words, all the additional money could be absorbed just to offset rising prices, leaving none to support any increase in real economic activity.
None of these relationships are fixed, however, particularly not in the short run. CBO, for instance, assumes the velocity of money will rise about 5 percent, instead of 3 percent, in 1982. But to come up with a 4.1 percent rise in real output, CBO also is counting on the Fed to allow money growth near the 5 1/2 percent upper limit of its target range, not the 4 percent midpoint.
Some other forecasts, such as that of the group of monetarist economists known as the Shadow Open Market Committee, assume the Fed will shoot for the middle of its range and that the increase in velocity will be close to its long-term trend. In that case, they said last week, real growth in 1982 could be zero to 1 percent rather than CBO's 4.1 percent or the administration's 5.2 percent.
Administration economists generally acknowledge privately that their 5.2 percent growth forecast is too high because interest rates have stayed up too long.
The high cost and scarcity of mortgage money, for example, has so depressed housing activity that starts of new homes fell in August to a seasonally adjusted annual rate of 937,000 units, the lowest level in five years. The figure for single-family houses was 591,000, a record low. With mortgage rates at 17 percent or more, no turnaround is in sight.
Similarly, interest rates have stymied businesses' long-term borrowing plans and have limited the prospect of increased investment in new plants and equipment next year.
But if 5.2 percent is too high, what is a better guess? Forecasters are all over the lot, though there is general agreement that a severe recession is unlikely. The trouble is, there is no previous experience in this country with either a sustained inflation or a sustained bout of tight money to combat it. Throw in the uncertain course of federal spending -- now that the revenue side of the budget has become essentially fixed as a result of the tax cut -- and forecasting becomes a particularly hazardous business.
Administration economists say if Reagan can engineer enough budget cuts to reassure investors that the deficit will be coming down in 1983 and 1984, the future is not bleak at all. "We have learned that it's unwise to assume that the best case is the most likely case," says one. "But we are not as far behind the eight ball as the current pessimism suggests."
Counter views come from a wide range of economists. Walter Heller, chairman of the Council of Economic Advisers in the Kennedy administration, believes interest rates will stay on a high plateau for "as far as the eye can see." George Perry of the Brookings Institution, who does joint forecasts with Heller, expects the economy to bounce up and down, with brief periods of perhaps strong growth choked off by restrictive money policies and rising interest rates -- a scenario not unlike the economy of the past year.
Henry Kaufman of Salomon Brothers, the investment banking firm, has been warning for more than a year that Reagan's economic approach, coupled with major increases in defense outlays, would boost interest rates repeatedly. "Our policy has put us into an economy that sputters and spurts," Kaufman declares. "Extricating ourselves will be very difficult."
Allen Sinai of Data Resources Inc. concluded, after a detailed study of the probable long-term results of Reaganomics, that while it would increase savings and encourage investment, it would also mean higher interest rates, a chronically depressed housing market, great pressure on state and local governments -- in short, "a greater tradeoff between monetary and fiscal policy in achieving national economic goals."
Initially, Reagan and his advisers claimed the conflict between fiscal and monetary policy would be avoided because interest rates would drop as investors gained confidence that the government would act forcefully to reduce inflation. Obviously, no such drop has occurred.
Now, with the economy stagnant or declining and money supply growth below target, rates appear to be coming down a bit. But financial market participants clearly have not been convinced that Reagan will be able to control inflation, and long-term rates are near record levels. Short-term rates, meanwhile, are likely to stay high because of pressure from federal borrowing and the needs of businesses, unwilling to pay so much to borrow long-term, for shorter-term bank credit.
That is why everything comes back to the size of the federal budget deficit. "For almost the first time," says economist Alan Greenspan, an outside adviser to Reagan, "the signals on long-term fiscal responsibility are a very important element of economic policy. However, there is a tendency to believe, I fear, that this is a public relations question, that one need only 'convince the markets.' "
Concrete action, not words, is the only answer, Greenspan says. "Markets are deaf, but they have 20-20 vision," he declares.
The response of the markets so far has speeded up the Reagan timetable. Now he must explain exactly how he plans to achieve not only a $42.5 billion deficit in 1982, but budget balance in 1984. Lopping billions off the projected deficit for "savings not yet proposed" won't work.
As Congress moves to deal with Reagan's newest round of spending cuts, there could emerge a national political consensus about what services Americans really want from their government. By cutting revenues so drastically, immense pressure is building to reduce present programs to a politically tolerable minimum.
Whatever that minimum turns out to be, the revenue to pay for it will have to be raised. That is the message the financial markets are sending to Washington.