Mankiw interview
GEOFF COLVIN: Well, in his State of the Union speech, President Bush said he can create more jobs and cut the budget deficit by half in five years, if Congress cooperates. But in just the past few days, a number of the President's supporters have attacked him for presiding over the biggest spending increases since the 1960s, which doesn't sound like a recipe for deficit reduction. A key player in turning the President's promises into specific proposals is N. Gregory Mankiw, chairman of the President's Council of Economic Advisers, who joins us from the North Lawn of the White House.
Professor Mankiw, Steve Moore of the Club for Growth was just described in The Wall Street Journal as calling the latest spending bill just passed, "A pork-laden monstrosity worse than any ever produced when Congress was controlled by tax-and-spend liberals." Now, how can the President sign that bill and expect voters to conclude that he represents fiscal discipline as he has long claimed?
N. GREGORY MANKIW: Well, the President's job is to set priorities, and the President inherited a series of events that requires spending increases in some cases. I mean the increases in defense spending, increases in homeland security are very important. But if you look at increases in budget authority, for other than defense and homeland security, you will see substantial spending restraint, and you'll see that in the President's budget that comes out early next month. Spending restraint's a very important part of the President's program.
COLVIN: But of course actually spending is often far more than the increase in budget authority, and this has been the case over the past few years. The actual increase in domestic discretionary spending under the President has been greater than under any President since Lyndon Johnson. Is this a fiscally-conservative approach?
MANKIW: The President is very definitely a fiscal conservative. If you look at outlays, which some people have been doing, you have to remember that sometimes outlays reflect the things that were authorized in previous administrations. So looking at outlays, as some commentators have done recently, is really not the right way to look at the data. You need to look at what this President is authorizing and what he's putting in his budget, and look carefully at the budget that comes out early next month and you will see significant spending restraint.
COLVIN: The President has said that he wants to control the deficit by limiting spending, which of course he can do by using the veto. Now the deficit hit a new record last year. It should be even worse this year, yet the President has not used the veto even once. Why not?
MANKIW: Well, the President might use the veto in the future. It's his decision. Our preference has been to work with Congress, not to be confrontational. I think if we work with Congress we can get spending under control. You're right that the budget deficit will be larger than we'd like this year. It's probably around 4.5 percent of GDP, but it's going to come down over time. We inherited a recession, and we had to deal with that recession. We inherited terrorist attacks, I mean to deal with those terrorist attacks. But the President is making the right choices, saying the right priorities. And as the economy reaches full employment over the next few years, we can see the budget deficit coming down, and he wants to reduce it in half over the next five years.
COLVIN: In a recent poll, about 60 percent of Americans said they would prefer to cut the deficit by canceling some of the recent tax cuts. Only 21 percent said they want to do it by cutting spending on programs like health and education. Am I right in believing the Administration will not even consider canceling any of the tax cuts, and if not, why not?
MANKIW: Well, the President's not only not interested in canceling the tax cuts, he wants to make the tax cuts we've put into law permanent. He doesn't think that raising taxes on the American people is the right way to go. He believes that low taxes, keeping money in the hands of the people who earn it is better for the economy and better for the American family, better for long-run economic growth and living standards. But that doesn't mean that we should abandon fiscal discipline. It means we need to watch every penny carefully. It means we need to keep spending under control.
COLVIN: And do you think that the budget deficit can be reduced completely without rescinding these tax cuts?
MANKIW: Well, you will see the President's budget early next month. I don't want to preview that. But what the President has said many times, that his goal is to reduce it in half over five years from about 4.5 percent of GDP now to about 2 percent five years from now. And I think that's a very doable goal, a very manageable goal, and one that will be very good for the economy.
COLVIN: Now, some people say that the President's tax cuts are intended to enforce spending discipline on Congress by essentially starving the beast. Is that the President's intent, and if so, why doesn't it seem to have been working?
MANKIW: Well, I'm not sure I'd use exactly those words. But if you say is it an important part of the President's plan to restrain government spending and leave more money in the hands of the taxpayers who earned it, the answer is yes. Spending restraint, tax reduction is an important part of the President's plan. The President promised that when he was elected in 2000, and he's delivered that.
COLVIN: Job growth seems to be the number one concern of voters right now, and the economy is back to creating jobs. Which industries do you expect to create the most jobs, and how many new jobs do you expect this year?
MANKIW: So far since the summer we've seen more than a quarter of a million jobs created in the economy. We've seen the unemployment rate come down from 6.3 (percent) down to 5.7 (percent). That's not far enough. We want to see more progress in the labor market, and we expect that will be coming. I can't predict for you which are the industries of the future. If a government bureaucrat like me could predict that, then central planning in the Soviet Union would have worked, and we know it didn't. It's the private market that's going to determine where jobs are going to be created, but there's a lot of growth industries out there. This is a very vibrant, dynamic economy, and I have no doubt that over the next year we'll see a lot of jobs created and the unemployment rate will be lower a year from now than it is today.
COLVIN: With the President being judged in part on this criteria and in the election coming up in November, do you think that enough jobs can be created that he will have a net increase in new jobs for his administration?
MANKIW: I don't have a specific number to give you today, but I think you'll see a lot of jobs being created. You've already seen signs of a very robust economic growth in GDP. The labor market tends to lag behind production, but once firms start producing, as they seem to be doing, they start hiring, and there's every reason to believe that that's going to occur. If you look at new claims of unemployment insurance, you see that those new claimants have been falling in number. That's an indicator the labor market's getting better. It's not good enough, but it's definitely getting better. We've turned the corner in the labor market.
COLVIN: Okay. N. Gregory Mankiw, thanks for your time.
MANKIW: Thank you.
Investing and politics
KAREN GIBBS: So now you know the White House's position. Will it fly on Main Street? And what about Wall Street? Does it make a difference which party is in the White House? Steve Leuthold is a student of politics as well as chairman of the Leuthold Group and manager of the very successful family of Leuthold Funds. He joins us from Tucson, Arizona.
STEVE LEUTHOLD: Nice to be here, Karen.
GIBBS: Thanks, Steve. Money manager Mike Farr is joining us in his new role as Wall $treet Week with Fortune's contributor, helping investors make sense of the often Byzantine world of politics. Mike, welcome to you, too.
MIKE FARR: Thank you, Karen.
GIBBS: So, without a doubt, the deficit and the unemployment rate are key political issues, but are they really issues that are affecting the market. Mike?
FARR: Well, I think so, clearly, because all of these lead to the financial structure of the country. What's our debt level, what's our interest cost, and what sort of money supply are we going to be able to maintain without seeing interest rates go higher, without increasing costs, so that Americans will still be able to find jobs and prosper. So it's this unique balance. We've seen this President I think cut taxes. You know, we used to see Presidents tax and spend. This one's had an interesting combination: cut the taxes and increase the spending. So the punchbowl is full, and we all should be partying.
GIBBS: Some say it's overflowing. Steve, where do you stand on this?
LEUTHOLD: Well, we used to say that Lyndon Johnson got us in trouble because he decided that both guns and butter could be supported by the government. Now we've got a President who says guns, butter, drugs, pork, pork, pork, and this omnibus bill that has just been passed, as I think as Geoff noted, is a monstrosity. I mean, we're providing money for the Rock and Roll Hall of Fame in Cleveland, we're providing $50 million for a rainforest in Iowa. I mean, it's just laden with pork.
GIBBS: But isn't that what the constituents want, Steve?
LEUTHOLD: I guess it's what the members of Congress want for their constituents, and I think maybe it's about time that more of our politicians started thinking about what's good for the country rather than what's good for the folks back home.
GIBBS: Mike, what do you say to that?
FARR: Well, I think so. I begin to wonder, too, what are the Democrats going to run on? Because the Republicans seem to be stealing all the good old Democrat issues. I mean we've got this Medicare bill. We've got bigger increases spending, immigration. You know, as you go down the list, the Republicans seem to be covering it, and they're throwing money at almost everything. So I think that this bill is way too expensive. I think somewhere in here, as much as I would think most of the Republican base would enjoy the tax cuts, sooner or later you do look for some sense of ultimate responsibility to say wait a minute, you can't cut the revenues and increase the spending. It doesn't work at my house long term, and it's not going to work long term for responsible government.
GIBBS: Is it reverberating, though, on Main Street? Look at what happened in Iowa, the whole caucus. It shook up everything, the campaign now. Is Bush as likely to win against a candidate that's not anti-war or say willing to roll back the tax cuts or may not be from the Northeast?
LEUTHOLD: Well, I think Bush is going to win, because it's the economy, and the economy is growing. We see with the polls in Iowa, the economy is the most important issue. And unlike his daddy, he's got an economy here that's expanding, that's growing. And that's how people tend to vote. That's the big issue, is their pocketbook and how well they're doing, rather than how the country's doing.
FARR: I think, too, that Steve is right, and in addition to it being the economy, and the economy is good, I think investors now -- you know, stocks are owned in over 50 percent of American households in some form or another -- so in addition to it being the economy, stupid, it's my retirement, stupid. And I think that with the average Baby Boomer now 57 years old, eight years from retirement, people are going to be listening to these candidates very closely for the statements that are going to affect the 401(k) plans and their portfolios, because they're going to need this money. Social Security isn't going to be the answer.
GIBBS: Steve, do you have a response to that?
LEUTHOLD: Well, I don't think it's going to be the answer either, and we have huge expenditures coming up here. Just if you look at what's been done with the Medicare program, starting in 2006, 2005, it's going to cost another $60 billion a year. After 2010, $200 billion a year. And if we don't do something in terms of bringing in some income, the deficit that we're looking at right now is, well, not child's play, but close to it.
GIBBS: Well, Steve, a lot of analysts talk about so-called Bush stocks, like drugs, tobacco, energy, that would do better under a Bush presidency. What do you say to that?
LEUTHOLD: Oh, I think probably to some degree that's true. We do have about 33 percent of our equity portfolio in healthcare stocks at this point. We haven't bought the big pharmaceuticals at this point, but I think they could be very attractive before long. The reason is, is that I think a lot of companies are going to find their way to work around the new Medicare legislation as its been established and written.
FARR: Steve, what do you think, you know, as you said, Bush is going to be reelected. I heard a study out of ISI that they did of their clients that said 90 percent of their client base of Wall Street subscribers thought that Bush certainly would be reelected. So the uncertainty now, the risk then comes into the market. I think what happens if Bush doesn't get reelected? What could shake this up where Bush wouldn't get elected, and how would the markets react then do you think?
LEUTHOLD: Well, Michael, I think if the economy suddenly fell of a ledge between now and election, which seems very, very remote, I think that could hurt Bush. If we have some kind of a huge scandal of some type, that could hurt him. And I think if you had another successful terror attack to show that our homeland security wasn't working, that could be in his detriment. But other than that, it's pretty hard for me to see how he's going to get defeated.
GIBBS: Steve, you said you have about 30 percent in healthcare. What don't you like? Where would you not be placing your money?
LEUTHOLD: Well, in looking at it over the next, say, year, I would really be very light in financial stocks, because I don't think there's any doubt in my mind that a year from now interest rates are going to be higher than they are today, and that has a negative impact on most financial stocks. The other area that I can't see, because I'm pretty positive about the market, I can't see seeing much performance out of those consumer staple demand stocks that so many in Wall Street have been talking about recently, the Coca-Colas and the food stocks and that type of thing. This is a market driven by earnings momentum, and I think over the next six months it looks very good.
GIBBS: Mike, candidate Howard Dean is calling for Greenspan, Fed Chairman Alan Greenspan's replacement, saying he's become too political. What do you think about that?
FARR: I think Howard Dean is such a fabulous example of one's ability to snatch defeat from the jaws of victory that perhaps we've ever seen. I mean what a classic flameout here, one to act anything but Presidential with that twist and shout thing he did on national television. And now to attack Alan Greenspan, you know, the guy who has upheld our economy, got us through 1987. It's awful tough to go after Greenspan. I think this is strike two, and he's probably out on strike two in this particular game.
LEUTHOLD: It looked like Dean was on an interview with the WWF or something. (laughter)
GIBBS: Steven Leuthold, Mike Farr, thank you very much for joining us.
FARR: Thank you.
LEUTHOLD: Thank you, Karen.
Social Security privatization
COLVIN: Conventional wisdom three years ago, as the markets were tanking, was that no one would ever again dare even to mention privatizing Social Security. How quickly times change -- President Bush just pushed for partial privatization in his State of the Union speech.
(Video excerpt starts)
President BUSH: "Younger workers should have the opportunity to build a nest egg by saving part of their Social Security taxes in a personal retirement account. (Applause.) We should make the Social Security system a source of ownership for the American people."
(Video excerpt ends)
COLVIN: So, suddenly it's a live, election-year issue: Should Social Security be privatized? Is that just a bonanza for Wall Street? Or is it the only hope for saving your benefits in a system that's otherwise doomed to collapse? A couple of former Wall Street titans do not agree on this. Donald Marron is former CEO of Paine Webber. He favors privatization. Senator Jon Corzine is former co-CEO of Goldman Sachs. He opposes privatization. Both guests join us from New York.
Sen. Corzine, 75 million baby boomers retire over the next 20 years. Either we extend the retirement age or increase taxes or cut benefits or privatize part of the system. Now given those tough choices, why do you oppose privatization?
JON CORZINE: Well, first of all, the privatization comes in a lot of different forms. Let me say I have some sympathy for investing some of the assets in private activities, but I don't believe we ought to fragment the system and pass out to each individual in the country a piece of managing their money, with different skill sets among different people, and maintaining a guarantee of benefits. That just doesn't make any sense to me.
COLVIN: Well, Mr. Marron, in light of those points, why should we want to privatize Social Security now?
DONALD MARRON: Well, we've got to go back to the beginning. When Social Security was started, it was very different that now. There were 26 people contributing for every one. The average lifespan was 61. You didn't get your benefits until you were 65. It's now three people contributing for every one, and the average lifespan is 76 years old. And most important, it was seen as a safety net. Now it is crucial for people. Almost 20 percent of the people who get Social Security, it's their only source of income. So what you have is a pool of money that is set up to do something very different from when it was first organized. Now why isn't that pool of money working? One main reason is the return on that money is only roughly about 2 percent. That's what the government is giving to us for the investment of our money. So if you can take a small part of it and in a very controlled way have it to get market returns for some of the people over a long period of time, you're going to have a way of bridging the gap, and the gap is crucial.
COLVIN: Sen. Corzine, why not? I mean if the effective return is only about 2 percent, you can do better than that, even with risk-free Treasury bonds. Why not let people do that with some of their money?
CORZINE: Well, first of all, let me respond. First of all, how you get from where we are today to where you go under the plan that Don has outlined is going to cost a trillion dollars out of the general funds to be able to have it. Unfortunately, we're running $400 to $500 billion budget deficits. People are talking about a $5.5 trillion budget deficit over the next 10 years, and I don't think we can afford it. Two, I don't think that if we're going to continue to offer a guaranteed benefit to every American -- and since this is the baseline, as Don talked about, I think it's absolutely essential that we continue that guarantee -- I think we need to be more secure in how we access those returns. So you might want to run it like a pension fund and have sophisticated investors and professional money managers work to improve that return with a portion of it, but I don't think that ought to be scattered out into 100 million hands, and then if they don't perform well, have the government have to step in and backstop that guarantee when that happens.
COLVIN: Mr. Marron, there's a key point that we haven't really resolved here. Do you favor, as the Senator does, the continuation of a guaranteed Social Security benefit?
MARRON: Well, here's the thing. There are several groups of people that are covered by Social Security, two of which have to be completely protected. The first is the low income people. It's a big percentage. Those are the ones for whom Social Security is their only revenue. They have to stay with the commitment they have now. They are the ones that you're scaring the most when you talk about the system having its problems. The other group are those that are 55 years and over who are going to retire, because there isn't enough time to have the market work for sure in changing their money. So what you have is the people that are in between, mostly the so-called Baby Boomers.
And Sen. Corzine is right. You can't let 50 million people invest their own money. What you can do, however, is take the view that a pension plan takes, which is given a long enough time and conservatively invested, money will do a lot better than 2 percent. Our recommendation in our commission was quite simple: only let people invest in index funds, a stock index fund, a bond index fund, or a blend. In that method, they're going to get roughly what the markets get, and the markets tell you that you can get a good return over time. Three groups of people, three different needs, so you have to protect two of them for sure, and you have to augment that third one over 20 or 25 years.
COLVIN: Senator, Mr. Marron mentioned a key group that has to be protected, namely low income people. And that raises an interesting point, because the Social Security tax is a regressive tax. Now wouldn't it lighten some of that burden if some of that money could be put into private investments?
CORZINE: Well, I think there is the idea of whether the private investments are managed by people who are familiar with financial markets, familiar with investment techniques, or whether it's going to be managed by individuals that have little or no financial literacy. About 80 percent of our high school graduates can't pass a simple financial literacy test. I think there's a real serious problem in presuming that if we start passing out this money, even to pick among various index funds, that we're going to get the kind of results that people are looking for. And now moving from the financial world into the political world as I've transitioned to, I think it would be one heck of an ordeal of trying to figure out who fits into which one of those three categories, particularly since a lot of people's economic circumstances change dramatically through their lifetime.
So I believe that we ought to maintain the guarantee, number one, that people are going to get a baseline set of protections in their senior years. Once we do that, then I think we ought to think about how we can improve the return. We're probably going to have to adjust the support structure or general revenue flow into Social Security. I don't doubt that. By the way, the President's tax cuts, once they're made permanent, could, if they were all taken away, you could cover that shortfall three times by the revenues that we're implementing by the tax cuts. And I think most Americans believe that making sure that we have a guaranteed benefit in Social Security is a very, very important idea.
Something is going to have to change if the numbers that Don talked about with regard to the number that we're paying into the funds, it's not going to be able to be the same pay-as-you-go system. But I don't think going to private accounts, as is often verbalized by many of the advocates, is the right way to go.
COLVIN: I think we'll be hearing much more about it as the campaign progresses, but gentlemen, we're going to have to leave it there for now. Senator Corzine, Mr. Marron, thanks for your views.
Viewer mail
COLVIN: Last week we asked you to send us your questions about politics and the Presidential race, and did you ever respond.
Kurt Hudson from Tempe Arizona asked a question lot of people are wondering about:
"Is there a correlation between a President from a particular political party occupying the White House and the stock market?"
GIBBS: As a matter of fact, there is, and it's not what most people expect. Conventional wisdom says stock markets prefer Republican administrations, but we've found that not to be the case -- stocks do much better under Democratic Presidents. Over a 75-year period there's a whopping 10 percent difference on the return in the stock market when Presidential party affiliation is taken into account.
One explanation from market historian Ned Davis: Markets do extremely well in years when an incumbent Republican wins, (and) keep in mind that the stock market is a leading indicator -- buying on the rumor and selling on the fact -- so that by the time the inauguration rolls around, the market may have already peaked.
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