How Will Obama Deal with the Federal Deficit?

Carl Sagan only talked about “Billions and Billions” of heavenly bodies out there in the universe, while Barack Obama, President-elect, talks about “Trillions and Trillions" - that’s Federal budget deficits, of course.

The Federal Government, according to the President-elect, is going to have to spend and spend, and create these kinds of deficits if it is to sidetrack the economic downturn and put people back to work.

On Monday, in his New York Times column, Paul Krugman, a supporter of this kind of spending, “Fighting Off Depression,” made the following statement:

This looks an awful lot like the beginning of a second Great Depression. So, will we “act swiftly and boldly” enough to stop that from happening?

Bush 43, during his reign, created more debt than all the administrations before him. So what is new in the Obama approach? Is it just the size?

One thing, which is new, is that the people coming into the Obama government believe in an active government and the ‘planned’ use of the budget to stimulate the economy. The Bush 43 team did not.

As I have said before, the Bush 43 team reminded me of the Nixon team that administered wage and price controls in the 1971-72 period. I remember very distinctly sitting in the room in the White House with George Schultz, Arthur Burns, Maury Stans, and others, watching these people administer wage and price controls with their noses turned up in disgust, doing the last thing in the world they believed in or wanted to do…control wages and prices.

This is the same feeling I got from Hank Paulson and Ben Bernanke…they really did not philosophically believe in what they were doing and really did not want to be doing what they were doing. A consequence of this was that they were not very good at it.

The general approach taken by Paulson and Bernanke in the financial crises was…throw “stuff” against the wall and see how much of it sticks. The important thing was to throw enough “stuff” at the problem so that enough will stick in order to defuse the crises. In performing this way, they did not look like they knew what they were doing…try this…no, try that…no, let’s do it this way…they were not disciplined…more is better…and they did not inspire much confidence.

Now, we have a team coming into power that believes in the use of the fiscal tools they are going to inherit and they have confidence that they can use them in a productive way. This is the difference between the Obama team and the Bush 43 team. How the Obama team executes its plans is very important because both international and domestic financial markets need to have confidence in the United States administration, something they have not had for at least seven years.

The lack of confidence in the Bush 43 administration was exhibited in the relatively steady, six-year decline in the value of the United States dollar - a decline in value of more than 40%. This lack of confidence grew out of the undisciplined way Bush 43 conducted the monetary and fiscal policies of the country. This lack of discipline in the Federal government set the tone for a growing lack of discipline in financial practices. International markets proved to be correct in that the entire financial structure built upon government, as well as private, debt and inflationary bubbles ultimately crashed.

In order to recover…confidence must be rebuilt!

This is why the appearance (and reality) of discipline is vital! Yes, the Obama team is proposing deficits that will be measured in the trillions. But, the spending and tax cuts that produce these large deficits must not be just throwing ‘stuff’ against the wall. There must be well thought out reasons for the expenditures and tax relief…there must be oversight and controls to accompany the programs…and there must be thought given to what is going to happen to all this spending and deficits once the corner is turned and the economy and the financial markets stabilize.

I know that this is asking a lot, since it was a lack of discipline that got us into the current situation and, the only long-term way to get us out of the current situation is to re-establish discipline over what is being done. If there is little or no discipline in what the Obama administration proposes, confidence will erode relatively quickly, and markets will continue to tank. Market support will only come from a belief in the commitment and execution of a believable plan.

The major parts of the Obama spending programs seem reasonable; build infrastructure, health care reform, education, and investment in new energy programs. Major emphasis on these things, however, is not “quick fix” solutions. They represent a commitment not only to government spending, but also to investments in the future that can build intellectual and social capital.

Economists have contended that government spending during the Great Depression never reached a level to really stimulate the economy until the spending connected with World War II came along. However, one of the benefits of the government spending during that war period was all of the innovations and new applications that resulted from the spending and ended up in new industries and further innovation in the post-war period that spurred on economic growth in the future. That is, the government spending did not just support the existing, out-of-date industrial structure of the 1930s (like our current car industry), but created the basis for a new structure, new jobs, and a new life.

There is still concern that the fiscal programs being proposed will have the desired effect on the economy and the financial markets. It has still not been proven that government spending can be substituted for private spending in order to create sustainable growth and permanent jobs. In has still not been proven that the world can absorb all of the government debt that is being created. It has still not been proven that the government can generate all of these deficits and not end up monetizing a large portion of them.

There is still a lot of uncertainty.

Financial markets want to believe in the Obama administration. Financial markets want to believe that the Obama team is competent. Financial markets want to believe that the economic package that is being constructed will work. Financial markets want to see discipline re-established.

However, the numbers are so large…

Comments

[Steven Hansen:]

"It has still not been proven that government spending can be substituted for private spending in order to create sustainable growth and permanent jobs. In has still not been proven that the world can absorb all of the government debt that is being created. It has still not been proven that the government can generate all of these deficits and not end up monetizing a large portion of them."

and that, John, is the problem in a nutshell. the government is trying to gdp fill (not stimulate). the systemic issues which have brought us to hells doorway are unresolved. it will take years to unwind our way from this economic disaster.

i fear, not only is this spending happening too early in the crisis, but we will be saddled with this debt and will create and additional mountain we must travel over before the economy can rebuild.

Jan 09 04:49 AM

[athena:]

The fact that we bandy about the word trillions so easily only shows that our currency is worth very little. I got sticker shock today when trying to purchase the usual cat food that is made in Asia. And that is how you bankrupt a nation, print money and all imports will be escalating and guess what, we dont produce anything here anymore- except derivatives and cars at a loss. And of course, munitions, so let the wars begin.

Jan 09 08:13 AM

[Sigmund:]

I note that the body politic is beginning to curtail its credit purchases and loan balances. Would someone please step up and say, hey let's start making things again. Things like energy efficient transportation. Let's start building nuclear power plants. Let's start being more rigorous in the schools. Let's stop money grubbing and start making things; let's be great again!

Jan 09 08:55 AM

[Duude:]

Sorry. I can't find anything I agree with in this article except that the incoming administration believes in spending and running up the deficit. But I don't believe this is a prescription for economic recovery. In fact, I believe its a prescription for disaster. Consider Mason's remark,
"The lack of confidence in the Bush 43 administration was exhibited in the relatively steady, six-year decline in the value of the United States dollar - a decline in value of more than 40%"
So, I guess he's inferring that the confidence of the incoming administration in spending trillions will somehow send the dollar on a bull run? Are you kidding me? The greater likelihood is after the Fed re-inflates the credit market, they will be dealing with a tremendous reversal on inflation. We might be better off putting our money in Zimbabwean currency. Not really, but certainly a hard currency anyway.
He also compared the Nixon administrations dislike for using controls on wages and prices. Is he somehow implying that government intervention would have somehow worked if those players believed in what they were doing?
Obviously, that type of government intervention is just plain stupid tinkering. It failed because its stupid economics.
Likewise, the Obama admin is pushing stupid economics. The economy isn't going to recover due to anything but lower interest rates, a re-inflated credit environment and time. I don't have faith in additional government spending. I have faith in full and free market capitalism. We've made this mess over two decades of bad policies that introduced moral hazard in a big way. We made our bed and need to sleep it off. I'm reading how the Obama administration is trying to shove this stimulus bill through as fast as possible. I think this is far more about politics than economic policy. The stimulus bill will take time to trickle into the economy no matter how fast they pass it. Any delays might make it clear that this stimulus isn't actually needed.

Jan 09 10:32 AM

[secmaven:]

Japan monetized trillions of yen government debt in the last five years and its currency is the strongest in the world. Why? Because Japan's economy is productive and operates under a rule of law. its currency, borrowed at zero interest rate, has become an engine of finance, providing the liquidity needed to facilitate much economic activity. If the world perceives our economy as strong and operating under a rule of law, ie. no Patriot Act arrests in the night and tax the wealthy out of existence schemes, etc. there is no reason monetization of our debt cannot work the same way it has in Japan. Obama promises to bring both discipline and creativity to the financial management of this country with much of the newly created money entering the system from the bottom up. This is a prescription for success.

Jan 09 11:37 AM

[henarl:]

All of the administrations for at least 60 yrs up thru Bush43 have been totally inept at controlling the economy for the better so it's no wonder that the average US citizen has little confidence in the abilities of politicians and bureaucrats.
However, Obama & Co. are just now stepping up to bat so lets give them a chance before we rank them.

Jan 09 02:54 PM

[Gold Barron:]

The deficit will increase under Obama administration.

Jan 10 09:36 PM

[TinyTim:]

" In performing this way, they did not look like they knew what they were doing…try this…no, try that…no, let’s do it this way…they were not disciplined…more is better…and they did not inspire much confidence."

Glad someone else feels this way. Good rationale for their actions.

Jan 13 08:04 PM