It's The Early 1990s Bond Market Again
Three decades ago, a president squarely focused on middle-out growth realized, much to his frustration, that the best thing to do for the nation's working class would hurt him politically — at least in the short term. The first Democrat to be elected President after
A Wall St sign hangs at the New York Stock Exchange (NYSE) at Wall Street on March 23, 2021 in New ... More York City. -(Photo by Angela Weiss / AFP) (Photo by ANGELA WEISS/AFP via Getty Images)
Reaganomics had blown a hole in the deficit, Bill Clinton understood that high interest rates for borrowers — small businesses, homebuyers, and ordinary consumers alike — were the primary barrier to broad-based prosperity. To bring those rates down in the service of more robust growth, he would have to do something voters of almost every stripe hate: pare back the federal government's deficit by cutting spending and raising taxes.
He did exactly that, and the economic growth that followed meant Clinton left office boasting the only federal surpluses in recent history. The lessons of his success bear heavily on the political debate today in Washington because, for the first time in 30 years, the yawning gap between federal revenues and federal outlays is poised to emerge again as the prime barrier to domestic economic growth. And yet the Trump administration's decision to put its head in the sand on this issue with its misnamed Big Beautiful Bill threatens today to cut the nation's working-class families off at the knees.
It's worth making the connections explicit because they explain both how this moment and 1994 are similar, and how they each differ from the economic fundamentals that held in between. Among the primary drivers of American economic growth are borrowing costs. If an entrepreneur is forced to pay more to borrow the money required to, say, build a new factory, she is less likely to do so. Borrowing costs are determined largely by interest rates — the higher the rate, the more it costs to invest. Interest rates are, in turn, heavily influenced by the bond market. And the bond market is heavily influenced by how bond traders perceive the federal budget. If, in their view, Washington is piling up debt such that traders are prone more to worry that the government will default, they'll raise the interest rate on federal bonds. And those higher rates then trickle down to the rest of the economy, raising borrowing costs, and slowing growth.
That's exactly what happened during the 12 years that Ronald Reagan and George H.W. Bush served as president — government spending growth vastly outpaced federal revenue. And by the early 1990s, high interest rates were making it much harder for businesses to invest. Clinton's election in 1992 reflected the public's economic frustration — but cutting the deficit means either slashing government spending or raising taxes, neither of which is popular with voters. So, Clinton used his deft political talents and a deep well of political courage to do what was politically difficult. And while that hurt Democrats in the short-term — no one working in the White House in 1994 (including myself) will ever forget the shellacking Democrats experienced in that year's midterms — he left office in 2001 with the economy and faith in government on solid footing.
The numbers bear this out. Because of the difficult choices President Clinton made, spending as a percentage of GDP fell to around 17.5%, and revenue as a percentage of GDP topped out at 19.7%. The results were sizable federal surpluses — and mortgage rates that declined by around 3 percentage points — saving middle-class families billions.
Unfortunately, over the next quarter of a century, both Republicans and Democrats have allowed spending growth to explode past federal revenues. Today, federal spending is over 23% of GDP, while receipts have dropped to 16.8%.
For a while, the bond market's reaction to the deficit's re-emergence was fairly muted. In the wake of the 2008 financial crisis, federal treasury bonds still appeared comparatively safe. So even as many in Washington warned about the dangers of sustained deficit spending, interest rates remained low, and domestic economic growth remained relatively strong. Today, however, the costs of all that debt are coming home roost. Like in the early 1990s, America's economy is up against a bond market that is flashing signs that borrowing costs are poised to explode.
The evidence is right there for everyone to see. The U.S. dollar index, which measures the value of the greenback against six foreign currencies, has dropped more than 8% since January. At the same time, U.S. bond yields have been rising, defying the economic pattern that defined the previous quarter-century. In times of uncertainty, investors typically flock to US Treasuries, viewing bonds as a safe place to park their money. The rising yields suggest the bond market is less confident in federal debt. And that flagging confidence is now poised to filter down through the rest of the economy.
This is perhaps the most important reason everyone should be so worried about the Republicans' Big Beautiful Bill. It would signal to an already skittish bond market that, far from taking the deficit seriously, Washington can't be stopped from digging its own hole. Three decades ago, Bill Clinton accepted the short-term political costs of bringing federal revenues and expenses back into line. The question today is whether those with power in Washington have any of the same wisdom or courage.
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