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Mark's Market Blog

3-21-09: Budget Deficits into Perpetuity

By Mark Lawrence

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The markets were mixed this week on news that Bernanke is spending $2T to bring down long term interest rates. He's doing this by buying 30 year T-bonds. The dollar immediately plummeted against foreign currencies, as everyone thinks this all but guarantees more US inflation. The Fed is using all of its powers to prop up American businesses. If this doesn't work, they're out of bullets. The market turned down in the second half of the week on this news, and on the CBO announcement (see below).

S&P 500, Dec 19 '08 to March 20 '09

All over the news wires there are articles with the headline "Bernanke says we have an exit strategy," meaning he knows how and when he'll get this money back. However, if you actually read the articles, you find that what Bernanke really says is "it would be nice to have an exit strategy."

Oil, metals, and commodities jumped up directly as the dollar sunk down. The government is basically printing money to buy back all these 30 year T-bonds, and it devalues the dollar.

Oil, March 19 '08 to March 20 '09

Congress, which more or less now runs AIG, forced them to reveal the counterparties to the contracts they have been paying off with their "borrowed" $180B. About half the money went to foreign banks; the other half went to US investment banks like Goldman Sachs who then sent half their money on to foreign banks. There's a couple uproars now, one over the AIG bonuses ("We need to keep our smart people," which would be the same smart people who have bankrupted their company and nearly this country), the other over the fact that most of the bailout money is going to foreigners. We already saw this in last week's blog, so it's no surprise to us. Curiously the German government is working overtime to make sure if they do an Opel bailout, none of that money will get to GM and the US. This will become an international issue in time.

Bernanke says we must fix the "too big to fail" problem. We need a safer way to shut down large nonbank financial firms without destabilizing the entire financial system. "Improved resolution procedures for these firms would help reduce the too-big-to-fail problem by giving the government the option of safely winding down a systemically important firm rather than keeping it operating," he said.

In my blog on banking crisis, I quoted Rogoff saying that our deficit would grow by about $10T over the next few years. The Congressional Budget Office (CBO), a respected group of non-partisan economic analysts, now agrees. The CBO figures predict Obama's budget will produce $9.3 trillion worth of red ink over 2010-2019. Worst of all, CBO says the deficit under Obama's policies would never go below 4 percent of the size of the economy, figures that economists agree are unsustainable. By the end of the decade, the deficit would exceed 5 percent of gross domestic product, a dangerously high level.

Federal Deficits. 1980 to 2020

Many Democrats were already uncomfortable with Obama's budget, which promises to cut the deficit to $533 billion in five years. The 2009 deficit, fueled by the $700 billion Wall Street bailout and diving tax revenues stemming from the worsening recession, is four times the previous $459 billion record set just last year under Bush.

The CBO's estimate for 2010 is worse as well, with a deficit of almost $1.4 trillion expected under administration policies. By the end of the decade, the deficit under Obama's blueprint would be $1.2 trillion.

Democrats won control of the government in part by appealing to how under Clinton they balanced the budget. Doubling our national debt will most likely not go over well with the public. Democrats are no doubt mindful of how Republicans recaptured Congress two years after Clinton was elected, and Republicans will no doubt be happy to remind voters that it was a Republican Congress that lead a Democrat President to balance the budget.

Where is all this money going? The standard thing to think is they should just spend less. The federal budget is, however, not very easy to change. Roughly speaking, the money is split evenly between defense, welfare and health care for the poor, social security and medicare, and interest on the national debt. We can cut defense in half if we quit fighting terrorists, but the rest of that money is considered politically untouchable. Everything else the government does doesn't really add up to much. Add in Obama's promised and popular universal health care, and the resulting projection is higher taxes, higher deficits, and higher inflation. Bluntly, there is no simple solution - Obama is going to have to cut the pie into smaller slices. Retired people are going to have less money, working people are going to work longer and pay more taxes, and everyone is going to get less health care and more inflation.

Federal Budgets. 2005 to 2008

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