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The Balanced Budget Payoff


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THE BALANCED BUDGET PAYOFF

Pop quiz: When was the last time the U.S. government ran a budget surplus? It was 1969. Before that? 1960. The government even ran deficits for seven years during the '50s. Through Republican and Democratic presidents, the ink mostly ran red.

That's why the probability cf a deal in Washington to balance the budget is a really big deal--one that corporations, consumers, foreign rivals, and, yes, even the markets, haven't yet fully appreciated. With all eyes on the process, the impact of the end product goes largely ignored.

Take interest rates. DRI/McGraw-Hill has simulated the impact of a budget balanced by 2002. Long-term interest rates will drop about two percentage points. The 30-year bond, now at about 6.5%, will go to 4.5%. The prime rate, now 7.5%, will fall to 5.5%. And 30-year mortgages, now going for 7.5%, will decline to about 6%. The nation will shift from a loose fiscal, tight monetary policy to a tight fiscal, loose monetary one for the first time in decades. That's great not only for housing but for all kinds of business investment. Better yet, the country doesn't have to wait seven years for the interest-rate bonus. Once the markets are convinced of the surety of fiscal discipline, the gains will come fast and

furious.

Take stocks. Without a balanced budget, the Standard & Poor's 500-stock index, now at 544, will rise to about 700 by 2002, according to DRI/McGraw-Hill. But with a balanced budget, the S&P index jumps to 900 in seven years, 27% higher. Again, the gains come quickly. By 1997, the S&P index is up to 670 instead of 560, generating many billions in new wealth.

Price-earnings ratios, of course, will be a lot higher, too, if competing bond yields fall sharply. In today's world of 6.5% long bond yields, p-e ratios in the U.S. are in the range of 16-17. Once rates drop down to 4.5%, p-e ratios bump up to 20-21. For Corporate America, this is heady stuff.

So while following the drama in Washington, keep in mind that the endgame has extraordinary economic significance. A balanced budget is about to be introduced into an economy that is already in a capital spending boom, with low inflation, high productivity, and a surging information-technology sector. Caveats about economic cycles aside, 6000 Dow, anyone?


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