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Mark's Market Blog

6-17-09: A Decade of Deficits

By Mark Lawrence

The Congressional Budget Office released updated figures last month for projections on the budget deficit. The CBO is generally considered a reasonably non-partisan group whose analysis is as good and fair as anyone's and more reliable than most. This time I dug a bit into their assumptions and I'm frankly stunned. Their projections are for the next ten years, and the latest numbers are in the graph to the right. Although they have historic numbers available, in fact 50 years of them in the same spread sheet, I am only looking forwards: the Bush years are over and will not be repeated, it's the future that interests me. I will note only that the largest deficit under Bush was $408B and, heinous as that was, would be the smallest bar on this graph.

This graph has certain assumptions behind it. Here they are:

  1. Unemployment would average 8.8% this year, 9.0% next year, then start to decline to under 5% by 2015.
  2. Inflation would be 2.2% next year, climbing slowly to 2.5% by 2018.
  3. Economic growth would be a 1.5% contraction this year, followed by 3.8% growth in 2010, then 4.5% growth in 2011, climbing to 4.7% in 2012 then declining slowly to 3.85% by 2019.
  4. The stress tests accurately project the banking crisis is nearly over.
  5. No expensive new government programs will be created.

These assumptions are, in my opinion, a ridiculous fantasy.

  1. The unemployment projections can, for example, be compared to the first five months of the year, or to the projections made by Rogoff based on the history of banking crises. Unemployment in the US was 9.4% in May and climbing. Rogoff projected that unemployment would peak at about 11.5% to 12.5% in about March of 2012. Today Obama announced that unemployment would hit 10%, still an optimistic number but better than his previous 8%. Basically the CBO is assuming the recession is over and layoffs will stop immediately.

  2. The Fed and their cousins in Europe have dumped several trillions of dollars into the market place. The result is that total government debt by the industrialized nations is set to double in the next couple of years. Meanwhile, we all have aging populations and huge retirement and medical costs coming up. The bond markets and China have spoken loudly about their view of this: They fear inflation will easily hit 5% in the next three to four years. The increase in interest paid on the national debt will raise the deficits by a large amount.

  3. Due to inflation, high interest rates, an aging population, and a projected on-going banking and housing crisis, many people (including me) are already forecasting a Japan-style "lost decade" where we have essentially no growth for ten years. It would be astounding if we had 3% - 3.5% growth after 2014; this would match the best performance in the last 40 years, the decade of the 90s. Far more likely in my estimation is 2% - 2.5% growth after 2015, half the growth rate projected by the CBO. The CBO projection of 4% - 4.5% is simply laughable.

  4. A couple of months ago Obama performed "stress tests" on our largest banks. This means examiners looked at the bank's assets and tried to project losses under "worst case" scenarios. For example, they assumed unemployment would average 8.9% in 2009 and hit 10.3% next year. In May the jobless rate reached 9.4%.

    The tests also figured credit losses through 2010, implying the banks' bad assets won't deteriorate much beyond that date. But banks hold about $1T in commercial real estate loans and the bulk of those losses won't show up for a few years. Corporate loans, credit-card debt, and construction loans also continue to sour in the face of the recession. Home foreclosures are only increasing in rate and expense. A 3% error in the estimated value of the banks' assets in 2010, for example, would mean another $300 billion shortfall in capital on top of the $75 billion the government has recently required banks to raise.

    By some estimates banks have nearly $500 billion in losses to work through if the recession unfolds more or less as projected. Looming losses will eat into future profits, as banks effectively earn their way out of the problem. In April the International Monetary Fund predicted write downs at U.S. banks will exceed profits by almost $200 billion through 2010. "Concluding the banks are going to be able to survive is much different than concluding they have a level of soundness that will let them - and encourage them - to step up lending as we need them to do."

  5. Finally, Obama continues to push for major health care reform. In the absence of a bill to analyze no one knows what savings and costs this would include, but most analysts are projecting $1.5T to $2T in costs over the next 10 years. Entitlement programs in this country have a solid history of exceeding the worst cost projections made.

    In addition to health care reform, the Pentagon continues to prepare fight the war to end all wars, in spite of the fact that every other nation has obviously ceded unquestioned conventional military superiority to us. We are currently building and flying the F-22 (left) and preparing to build over a thousand F-35s (right). These airplanes have no credible competition or targets: although the F-22 has been in service for some years, it has not been deployed in Iraq or Afghanistan. Also, since Russia and China so adamantly refuse to build modern fighters for us to shoot down, we're apparently preparing to fight an invasion of T-4 Terminators, as we're currently funding development of a whole slew of unmanned aerial fighters.


    T-4 Terminators





In summary, I think the CBO has made some insupportably rosy projections. I think growth will be substantially lower, tax revenues will be lower, unemployment will be higher, pay outs to the unemployed and under employed will be higher, there will be some form of health insurance reform and it will be costly, and the deficits will be substantially higher. For nearly 30 years Republicans have cut taxes without regard to deficits, daring the Democrats to raise taxes. Obama, Pelosi and Reid are showing us a new kind of Democrat that puts their programs in place without regard to deficits, and dares the Republicans to not raise taxes. The losers of this game of chicken are the taxpayers, who are left paying for Johnson-Great-Society-style foreign excursions and huge new entitlement programs. We'll be paying through increased taxes, increased unemployment, decreased growth and increased inflation - what Reagan called "the misery index". My projections are below, and frankly, when I look at them, I think I've been too conservative in my estimates: I doubt things will play out even as well as I project.

CBO forecast ($B)
Deficit unemp inflationgrowth Debt
$1,845 8.8% 2.1%-1.50% $12,415
$1,379 9.0% 2.2%3.77% $13,794
$970 7.7% 2.2%4.51% $14,764
$658 6.6% 2.2%4.71% $15,422
$672 5.6% 2.3%4.60% $16,094
$749 5.1% 2.3%4.42% $16,843
$785 4.9% 2.3%4.12% $17,628
$895 4.8% 2.4%4.05% $18,523
$949 4.8% 2.4%3.98% $19,472
$1,023 4.8% 2.5%3.86% $20,495
$1,189 4.8% 2.5%3.84% $21,684
Mark's forecast ($B)
Deficitunemp inflationgrowth Debt
$1,845 9.8% 2.1%-1.5% $12,415
$1,500 10.4% 2.2%-1.0% $13,915
$1,200 11% 2.2%1.0% $15,115
$900 10% 2.8%3.0% $16,015
$920 8.5% 4.5%2.5% $16,935
$1,060 7% 5% 2% $17,995
$1,100 6% 5% 2% $19,095
$1,230 6% 5% 2% $20,325
$1,300 6% 5% 2% $21,625
$1,400 6% 5% 2% $23,025
$1,600 6% 5% 2% $24,625

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