Budget Deficit Screams Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The Obama administration released revised estimates for the 2009 budget deficit (the difference between the yearly income and spending of the federal government) today and it now looks like it will come in at $1.75 trillion. The original estimate for the 2009 deficit made by the Bush administration in February 2008 was $407 billion. Yes, the current estimate is now more than four times the original one... and we're not done yet. For a perspective of just how huge this number is, the largest U.S. budget deficit so far according to official figures was in 2004 and it was $413 billion. The current estimate represents over 12% of GDP (the overstated official number), approximately equal to the percentage in the World War II year 1942. As bad as a$1.75 trillion budget deficit is you can assume it is a gross underestimate of the actual number.

How the original 2009 budget deficit figure was obtained is not immediately clear. The Congressional Budget office estimated a deficit of $219 billion, which did not include the $168 billion stimulus plan passed early in the year. Adding those two numbers together, you would get $387 billion. Spending for the Iraq war was also not included in the number. If you use the current absurdly low estimate of only $170 billion that would bring the figure to $557 billion, not $407 billion (much Iraq war spending seems to somehow be kept magically out the budget). I frequently run into arithmetic problems such as these when looking at government reports. Nothing adds up correctly and the final number looks much better than what you should be getting from the component parts.

There were a few voices that were questioning the deficit numbers back in early 2008. Bill Gross from Pimpco warned that the budget deficit could rise to 5% of GDP and be as high as 600, 700, or even 800 billion dollars. We at the New York Investing meetup predicted that the first trillion dollar deficit would take place during the Bush administration. While this was considered an outrageous claim at that time, it was actually too low. As with much of the Credit Crisis, things have turned out to be even worse than the most dire outlook.

No one really knows what the actual budget deficit or national debt (the accumulated debt over time) is. Many items don't appear in either and this is not limited to Iraq war spending. Toward the end of last year, it was estimated that $8.5 trillion has been spent on trying to deal with the Credit Crisis. Most of that money is not included in the budget deficit or national debt. Future obligations for social security and medicare/medicaid are also ignored. Accounting for those could raise the national debt to the $50/$60 trillion level, if not more.

Where is the money coming from to pay for all of this spending? The major source is through 'printing'. While you can not print more and more of your currency and not have it devalue (the correct definition of inflation), this doesn't stop top economists such as Paul Krugman and Noriel Roubini from constantly opining in the media about the dangers of deflation. Just in case the 'experts' are misguided on this one, you might want to pick up some gold and silver during their current pull back. Oil, another inflation hedge, is also a great buy at the moment.

NEXT: Citi Dives, GDP Plunges - Both Off the Cliff

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Latest From Davos Switzerland

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The invitation only annual World Economic Forum - a meeting of world leaders, central bank heads, economists from big financial firms, and billionaire investors - is currently taking place at Davos, Switzerland. In an opening forum, the people who pull the strings of the global economy and stock markets came to the following conclusions (long after they have been obvious to everyone else):

1. The world is facing unprecedented economic challenges.
2. Fiscal packages may not be enough to restore economic growth.
3. The multilateral financial system needs strengthening.

Fortunately, George Soros gave an early talk that had somewhat more substance than the above long-on-platitudes and short-on-specifics comments. At the same time, Nouriel Roubini who is in Switzerland, but possibly not at the conference, released a purposely well-timed statement about just how costly it would be to fix the banking system.

Soros stated that the current crisis has the potential to be worse than the one during the Great Depression in the 1930s. According to his calculations, the global banking system in developed countries still needs an additional $1.5 trillion to be rescued. Furthermore, the only way to pay for this is with money creation, or in other words - inflation. Nouriel Roubini now says that he estimates the total global bank losses from the Credit Crisis will be $3.6 trillion, far higher than his original estimates (and mine as well, last July at a talk at St. Johns University, I estimated $2 trillion, which was double the consensus at the time). Roubini further stated the biggest U.S. banks are insolvent (New York Investing first said Citibank was insolvent at the end of 2007).

Expect some talk about the two approaches to fixing failed banking systems. These are the Japanese model and the Swedish model. The Japanese reacted to their failed banking system in the 1990s by propping up as many failed institutions for as long as possible and the consequence was economic and stock market stagnation that has now lasted almost two decades. The Swedes had a banking collapse in the mid-90s and took that opposite approach. They took swift and drastic action, which was painful in the short term, but proved highly successful and their economy revived quickly. So far, the United States has come closest to the failed Japanese model in dealing with the banking crisis. The political will to step on some very rich and powerful vested interests has been lacking as has the willingness to admit that top U.S. banks such as Citibank and Bank of America are insolvent.

One person that is not yet at Davos is Federal Reserve chair Ben Bernanke. He is busy keeping fed funds rates at zero at the Fed meeting in Washington. The meeting ends today and presumably he will be jetting off to Switzerland shortly thereafter. Expect the quality of debate at Davos to suffer accordingly.

NEXT: Government Wants to Play Good Bank, Bad Bank

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.