Federal Deficit No Big Deal

February 18, 2003
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GRAND RAPIDS — The economy may remain a concern for 2003. The re-emergence of federal budget deficits won’t, nor is there much concern about any substantial rise in interest rates until the economy gets moving.

Compared to the 1980s and early 1990s, the deficit included in President George W. Bush’s $2 trillion 2004 budget and those in preceding years are small, said Mike Manica, president of Grand Rapids-based United Bank of Michigan.

The U.S. economy is also far larger than a decade ago, making it even less of a concern that government borrowing needed to cover the federal deficits will siphon capital away from the private sector, driving up interest rates.

“When you take a look at the size of the deficit in relation to the size of the economy, it won’t make that much difference,” Manica said. “In the size they’re talking about, it will be almost negligible.”

In addition to the projected $307 billion for the current fiscal year, and $304 billion in FY 2004, the federal government is looking at deficits in future years due to what is described as “the need to fund new priorities and a cautious forecast.” The federal deficit will decline in each year after FY 2004 to $190 billion in 2008 and, at 2.7 percent of the GDP for 2004, is “manageable and modest by historical standards,” states a White House fact sheet on the budget plan.

Gregg Dimkoff, a finance professor at Grand Valley State University’s Seidman School of Business, believes there’s very little to worry about with the return of federal deficits, especially when you compare them to those of the 1980s and 1990s.

“The economy’s bigger and can take it now,” Dimkoff said. “I haven’t heard anybody get that excited about them. They’re just not that big comparatively to what we used to have.”

Dimkoff, in fact, doubts whether the so-called “crowd-out theory” involving the effect of deficits on capital and interest rates even exists, saying he’s never seen any evidence of a correlation.

Looking at the year ahead, neither Manica nor Dimkoff see interest rates, now the lowest in more than four decades, going upward until the U.S. economy strengthens.

Manica doesn’t expect any movement in interest rates until June at the earliest, and then corresponding movements once the economy, as projected, begins to pick up.

United Bank of Michigan, which has a loan portfolio of $260 million, 80 percent of which consists of commercial loans, has seen many businesses refinancing existing debt, particularly in the three- to five-year range or for debt that’s about to mature, Manica said. A five-year note nearing maturity likely carries an interest rate of around 8 percent, he said. Business could now refinance for less than 6 percent.

Many businesses have sought to take advantage of the low interest rates and Manica doubts that demand for refinancing business debt will taper off anytime soon.

“They want to put their financial house in order for as long as they can,” he said.

With plenty of uncertainty about the economy and war with Iraq, demand for capital to finance business expansions remains low, he said.

“We just don’t see that many people coming in and saying, ‘I need the next generation of machinery,’ or ‘I need a new plant,’ or ‘I need more floor space,’” Manica said. “We’re just kind of stuck in neutral.”

Neither Manica nor Dimkoff see interest rates moving upward until the economy gets in gear. Many economists believe the economy will pick up in the latter half of this year and into 2004.

That leaves businesses that haven’t already sought to refinance existing debt or secure new capital plenty of time to act and take advantage of the low interest rates, Dimkoff said.

“Until the economy picks up steam, they are not going anywhere,” he said.    

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