Monday, December 15, 2008

Government deficit set to balloon: Why shouldn’t we worry?

The budget deficit is already estimated to reach $1 trillion (yes, $1,000,000,000,000) in 2009, and that doesn’t include the $300 billion, no $500 billion, no $1 trillion stimulus plan. When is it okay to worry?

If the only new federal outlays were in relation to the second ECONOMIC stimulus package, then I wouldn't be as worried. However, the U.S. government has already funneled $1.06 trillion into stemming the credit crisis, leaving little wiggle room for Obama's latest $1 trillion stimulus package. Time to worry.

There is some debate over how quick and what type should be the stimulus package. Within one publication of the Economist, there are inconsistencies.

From the Economist on December 11, 2008:
For once, politicians and economists agree the deficit should not be a worry. The credit crunch and the collapse in the stockmarket mean households are trying to consume less and save more. But for them to do so collectively, some other sector must consume more and save less. Corporations are not going to do it: they are cutting investment and hoarding cash in the hope of staving off a liquidity crisis or even bankruptcy. Demand is not going to come from the rest of the world: many other countries are in recession. Even in China, which is still growing fast, demand for foreign goods is contracting sharply: by 18% year-on-year, according to figures released on December 10th. So that leaves the federal government.
Also from the Economist on December 11, 2008:
Quick and easy is not the same as good

The danger comes when these two objectives conflict. Given that stimulus is likely to be regarded as the primary aim, a premium will tend to be placed on actions that yield the most rapid results. America’s governors are already falling over each other to submit their lists of “shovel-ready” projects to Washington, DC.
But quick and easy is not necessarily good.

The federal government is not good at discriminating between infrastructure schemes. Too much cash has gone into encouraging sprawl or keeping senators from small states happy with showy projects; too little into building things that are harder to get approved but encourage economic growth or control congestion, such as light railways or road-rail freight systems. Obviously each project should be measured on its merits. But a good broad test will be where the money goes. The 100 biggest metropolitan areas account for 65% of America’s population and 75% of its output. That is where the infrastructure is needed. But if “bridges to nowhere” start springing up in the boondocks, it will probably be money wasted.
Even though politicians and economists agree that a stimulus package is prudent, they certainly don’t agree on what fiscal package is required. Quick and easy or tax breaks versus spending. Mark Thoma points out the different stimulus effects between tax cuts and spending.

The problem: in reference to whether or not government debt should be a consideration, the stimulus debates leave out the spending that has already occurred to stem the financial crisis. These outlays already total $1.06 trillion, afforded only by newly issued government debt.

The table lists the current and maximum funding allocated by the fiscal sector to shore up the financial system. The government has already spent $1.06 trillion on the financial crisis, but allocated up to $3.67 trillion. And with the Citigroup allocation not even tapped and the TARP funding most likely to be spent with Congress' blessing, the outlays could very well approach the $3.67 trillion.

To be sure, the fiscal outlays for the financial crisis are different from those associated with the stimulus plan, as many of the listed outlays are in the form of a loan, and (hopefully) will eventually be paid back. But they are still outloays. And the Obama stimulus plan gains traction with each week that passes:

On October 15, Democratic leaders said $300 billion.
On December 1, Pelosi says $500 billion.
On December 13, Obama’s team implies that $600 billion is a LOWER BOUND; the price tag will be upwards of $1 trillion.

Who knows, next week it may be $1.5 trillion. It worries me that Congress is working in crisis mode and not thinking clearly. Obama expects to spend $600 billion in the first year – that’s a $1.6 trillion deficit in 2009 – without the rest of TARP funding, the Citigroup bailout and any other allocated funding – or roughly 11% of GDP.

Sure, economists and policymakers can tout that debt accrual should not be a worry, but I completely disagree. More is not necessarily better. Just one month ago, Paul Krugman called a $600 billion stimulus package “huge”! What has changed since then?

As soon as the government becomes comfortable with $700 billion, they up the ante another $200 billion. More gets you through the next year, but what about in 10 years?

Rebecca Wilder


  1. Good charts, as usual! In 10 years, those same charts will be listed in trillions vice billions. The Congress needs to take its own advice (to the auto makers) and have a very specific plan for all that $$$$$$ and what it will accomplish.

  2. If current projections of Federal Deficits materialize in this, and the next few years, interest rates (both long and short-term) will be driven up sharply by the increased demand for loan funds.

    I.e., any recovery in the economy will present a “Catch 22” situation.

    An upturn in the economy will add increased private demand for loan funds to the insatiable demands of the Federal Government.

    The consequent rise in interest rates will effectively abort any recovery.

  3. What a disaster in the making.

    Governments too, at all levels, need to consume less and steal less from the citizenry (taxes).

    Through their acts, Citizens as individuals and owners of businesses are saying:

    "The current mix of things being sold, at their prices because of the manner in which they are made are not the things we want to buy.

    Further, because we see that others cannot earn enough income from what they sell, we cannot trust them to extend credit to them to buy the things we sell."

    The Economy is out of balance with too much government and too much bad manufacturing (GM, Ford, Chrysler; oil-based energy) and too much credit-card based consumption and not enough future manufacturing (composite materials, natural gas and other based energy).

    Clamoring for more government lengthens the time for self-adjustment, self-correction of the economy as it blinds individuals from seeing new futures.

    What needs to happen is a full change to the tax laws regarding new venture formation (cash for capital investment), to income earned (eliminated) and to cash spent for consumption (increased).

    Big Government in the USA and it's operating basis of Collectivism is a failure.

    Big Government alone through it's picking of winners and losers (subsidies, tax breaks, contracts and spending) has caused this Economic Collapse.

    The sooner Americans de-program themselves from the Cult of the U.S. Government and Big Government America, the sooner Americans can arise from this calamity.

  4. To repeat, to appraise the effect of the FEDERAL BUDGET DEFICIT on INTEREST RATES, it is necessary to compare the deficit, not to GDP, but to the VOLUME OF CURRENT SAVINGS MADE AVAILABLE TO THE CREDIT MARKETS.

  5. Rebecca "Just one month ago, Paul Krugman called a $600 billion stimulus package “huge”! What has changed since then?

    As soon as the government becomes comfortable with $700 billion, they up the ante another $200 billion."

    This is why I quit managing money 11 years ago. When "irrational exuberance" becomes rational, there is an unknown limit as to how far is too far. It took us over 10 years to finally get the answer, but nobody knew at the time whether it would be 1 year or 20.

    The same with debt accrual. We kinda know it's too much already, but we don't know where the tipping point is or when it will occur. Personally think next year could be a real teaser and the breaking point, but as I was over 10 years too early last time, what I think doesn't really carry too much weight! More importantly, reading between your lines, are you implying something similar?

  6. Yes, there is disagreement over the multiplier effects of tax cuts versus spending. But there is no disagreement about the solution to the current failure in aggregate demand: we need consumption of some kind, either personal or governmental or both. Tax cuts will only stimulate personal spending if they are directed at those at the lowest income levels. Tax cuts designed to stimulate investment have a poor track record. The only thing the Reagan tax cuts and the more recent Bush tax cuts stimulated was the wallets of the wealthy. And no matter what the multiplier of infrastructure spending may be, at least it gets spent. The trillions being injected into the financial system right now are getting dumped into a huge black hole on the other side of thousands of bank vault doors. If that money was really accomplishing anything we would have noticed Libor rates collapsing by now and they aren't. The bottom line is give money to those with modest means and spend government dollars on infrastructure if you want to see the economy bounce back. Forget about TARP and similar expenditures. It isn't accomplishing anything.

  7. Steve B. "we don't know where the tipping point is or when it will occur"

    There's no analysis that will give anyone, the time, or a level, that the interest burden on Federal Debt will become insupportable.

    It depends totally upon the perception of investor confidence -in the credit and faith of our government.


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