This past week, while you were watching the Geneva summit story unfold on television, did the thought ever occur about the tie-in the summit meetings might have had with the fixed-income market? Sam Nakagama, a socio-political economist who writes a weekly market letter, has been referring to this political-economic topic for the past few months.
In essence, both sides are being affected by the heavy fiscal drain needed to finance arms buildup. Since the Soviet system is so different from ours, it is hard to make a comparison. But one thing is certain: the Soviets and their satellites are either bankrupt or close to it, primarily because of the uneven emphasis placed on arms spending at the expense of consumer expenditures. Consequently, the Soviets would love to shift more of their resources to the consumer sector of their economy.
In the U.S. political system, the effects of government policies are out in the open for all to see. One result of this administration's economic policies has been the huge federal deficits, the large trade deficit and the overvalued dollar. These ever-increasing federal deficits have to be financed in the U.S. Treasury market. And that's what caused the big flap concerning the debt-ceiling extension prior to the summit. Tied to the debt-ceiling extension bill was the Gramm-Rudman-Hollings amendment, which calls for reducing the budget deficit by $36 billion a year in an effort to achieve a balanced budget by fiscal year 1991. Had not Congress approved a temporary extension of the debt ceiling, the president would have gone to Geneva with the possibility of a fiscal collapse hanging over his head. With the $80 billion extension, the Treasury is now able to undertake several of its postponed financings that are needed to keep the government running.
The bottom line for all of this is that, since 1981, the attempt to to combine massive tax cuts with huge rearmament expenditures has led to the huge budget deficits as there has been an inadequate revenue base to support the arms buildup. In other words, an arms-control agreement was also important to the United States to reduce defense expenditures. To quote Nakagama, "the rearmament effort has been financed by a massive rise in federal debt, including a growing mountain of debt owed to foreigners." On top of this, the Gramm-Rudman amendment, if passed as proposed, would require the administration to choose between "substantial tax hikes or some form of unilateral disarmament." Certainly a realistic concern for the administration while attending the summit. In fact, the bond market rallied late Wednesday on the rumor that congressional conferees, meeting on the Gramm-Rudman amendment, had reached some sort of agreement that would help reduce the budget deficit. Certainly an arms control agreement between the two super-powers with its implied opportunity to reduce defense spending would have caused the bond market to rally even more.
On Wednesday, the Treasury will offer a 5-year, 2-month note in minimums of $1,000. They should return 9.2 percent.