Increased Deficit Spending: We Can't Afford It

At some point the numbers simply become too big to comprehend. I’m not sure that the human brain was meant to be able to contemplate deficit levels rising to the trillions and I’m confident that our founding fathers would barely recognize the enormous consuming government we have built over the last 233 years.

As the US government attempts to spend its way out of a recession, the newest projections point to astronomical increases in deficit spending. According to the Congressional Budget Office, we are looking at a 10 year deficit of $7.14 trillion dollars. This figure is a full $2.7 trillion above the level projected when the prior report was released in March. One can only imagine what this deficit will look like when we tally up expectations in another three months.

Not to be outdone, the White House has its own projections which include future changes in policy which will be put into place over the coming years. (The CBO projection is based entirely on current policies as if they would remain static for years to come). The White House expectations push the 10 year deficit to $9.05 trillion and at the same time, the administration expects the US economy to shrink by 2.8% this year. That’s a far cry from the 1.2% prior estimates.

Nouriel Roubinin published an interesting article in the Financial Times over the weekend discussing the risk of a double dip recession. We will be unpacking this article in a bit more detail in our newsletter this week, but suffice it to say that the potential for a much longer period of contraction is quite sobering.

The budget report is an interesting set of data considering the official GDP revision is due out this week. Remember the markets were extatic when the original second quarter release showed the economy contracted by “only” 1%. Now analysts are expecting that number to be revised to negative 1.5% and there is still a third adjustment which will be released in a few weeks. The strategy appears to be to show the best numbers immediately in order to juice the markets, and then let the details leak out in the less-followed revisions.

A higher market could become a self-fulfilling prophecy for at least some time as we are seeing consumer confidence begin to pick up. This morning we saw a reading of 54.1% from 47.4% in July which actually indicates consumers are expecting a more positive environment (as opposed to a less negative environment).

As consumers begin to feel more confident, traditionally you would see retail spending begin to pick up and economic recovery could create its own momentum and lead to further strength in the market.

However, I belive the current environment lacks much of the dry powder that would have been available to consumers coming out of prior recessions. The destruction of wealth in the form of lower real estate prices is one significant damper. At this point, personal debt is also at an unsustainable level and banks are extremely fearful of lending capital to consumers.

So even if consumers are more confident, there will likely be less of an uptick in spending (if there is any at all) simply because consumers don’t have access to any capital to spend.

It’s a lonely road to be bearish on the current market as more and more colleagues are jumping into invstments. However, save a few individual situations, I don’t see much in the way of attractive investment opportunities. While clients have made some significant gains owning stocks during the spring rally, we have spent the last several weeks pulling cash out of the market in order to protect against risk.

As a country, we can’t spend forever without absorbing the cost of this recklessness. At some point we will either have to raise taxes significantly (and I guess that’s already in progress) in order to pay for these programs, or we will need to print money to offset our liabilities.

Both are dangerous. Raising taxes and interest rates will likely derail any economic recovery and our administration knows this (whether admitted or not). The only other option is to monetize the debt (print currency) which can be excessively inflationary. It may take some time, but I strongly believe this is the direction we are taking.

So buckle up – cut back on risk – and take some defensive measures. Uncle Sam has pulled out the checkbook and is not likely to put it back anytime soon.

Comments

[chap08:]

Depends what you mean "cut back on risk". Do you mean move in to increasingly worthless cash and treasuries???

Aug 26 07:13 AM

[jamesa40:]

I don't know that I totally agree on your 'dry powder' comment. Sure the real estate bubble has taken a lot out of the market, way more so than in prior recessions, but the fact that bank lending has dried up? That happens in every recession. In good times, the capital flows. In bad times, the banks reel it in. The difference this time may be more that the consumer will have accumulated too much debt and will have to pay that down, thus not needing bank financing. That's different.

Aug 26 08:16 AM

[Paul Price:]

Zach,

I agree that the deficits area huge problem.

Investors don't want to be caught holding rapidly depreciating US dollars and the main alternative should be/would be shares of stock or commodities that can be marked to market upwards as the US $ heads south.

Aug 26 08:21 AM

[The Geoffster:]

Anyone worried about deflation need only "get their head around" the word "trillion."

Aug 26 09:08 AM

[tunaman4u2:]

I saw today that the monetary base rose from 800 billion to 1800 billion in just a year... thats a lot of money printing.
While it seems important to talk about the budget deficit it seems that the inflationary printing will keep the spending going.
How are you allocating for this risk as a market bear?

Can we hold cash to mitigate risk or is holding cash the risk with the Feds actions?

Aug 26 09:53 AM

[Jason Rines...:]

Why do you insist Cetin or whomever you are to be the chode of the Internet? You know how to do digital marketing but use your mind for raw spamming rather then collaborating with other bright minds.

Yes, there is going to be a double dip and no cushion left for the consumer. When you ignore the pillars of Main Street for a decade, and keep taking it out on the little guy, the pillars crumble and the those on the top of the platform topple with it. The United States will face a de-facto default. Notice the moves by the IMF and global currency. When the US is no longer the worlds reserve currency, the money printing will move from inflationary to hyperinflation worse then the 1979-1982 period but I don't believe quite as bad as Weimar Germany. A lost decade from here is an understatement.


On Aug 26 10:25 AM MIT mathematics & economics wrote:

> Without fail it's the ol' 7:00 AM housing pump. better than expected
> as usual. Everything is better than expected. Losing your jobs is
> better than expected. herpes is, too.
>
> Yup, everything is good in better-than-expected-t...
>
> This market isn't capable of going lower, plain and simple. We are
> in a bull market that may possibly last for decades due to aggressive
> fed policy, globalization, dollar devaluation, and resumption of
> consumer overindulgence. That's why I'm long MA POT GOOG for now
> and forever.
>
> good articles 4 slow news day: www.iamned.com
>
> 20 years from now we may still be waiting for the pullback that will
> never come.

Aug 26 12:24 PM

[WheelsComin...:]

"The budget report is an interesting set of data considering the official GDP revision is due out this week. Remember the markets were extatic when the original second quarter release showed the economy contracted by “only” 1%. Now analysts are expecting that number to be revised to negative 1.5% and there is still a third adjustment which will be released in a few weeks. The strategy appears to be to show the best numbers immediately in order to juice the markets, and then let the details leak out in the less-followed revisions."

This is the key, isn't it? Numbers are ALWAYS revised lower a few months down the road, yet the market has already popped on the "better-than-expected" numbers. You never hear about a pullback based on the "revised" figures. TOTALLY irrational market right now. But, those traders have to keep making money somehow...

Aug 26 12:37 PM

[inthemoney:]

> While it seems important to talk about the budget deficit it seems that the inflationary printing will keep the spending going.

With about 80% of americans living paycheck to paycheck I don't think inflation fears will force them to spend more. They don't have the money to spend. Of course, these are not people investing in stocks in the frist place. But they are the consumers, responsible for much of the GDP. Infaltion will only make everything more expensive since wages are nbot going to match inflation. So, the consumers will be even worse off. It is not a good news for US market oriented companies.
While some stocks, like commodities might be a good protection against inflation, the consumer disrectionary and casinos and autos and airlines stocks are not.

Aug 26 03:17 PM

[JJJ:]

I keep hearing that our debt to Gdp ratio is around the 40% range from the CNBC talking heads, and that this latest revised 9 trillion 10 budget deficit will bring us near 80% debt to GDP. Just looking at our current national debt of about 11.3 trillion and a GDP of around 14trillion(rounded up), Isn't the debt to gdp ratio already above 80%(11.3t/14t)? Am I missing something here.


On Aug 26 08:21 AM Paul Price wrote:

> Zach,
>
> I agree that the deficits area huge problem.
>
> Investors don't want to be caught holding rapidly depreciating US
> dollars and the main alternative should be/would be shares of stock
> or commodities that can be marked to market upwards as the US $ heads
> south.

Aug 26 05:20 PM

[TeresaE:]

Over 6 years into Michigan's "One State" recession, this is what I know.

Governments ALWAYS over-estimate tax revenues, especially when they "raise" taxes and then the reality of fewer businesses and taxpayers (result of higher taxes/expenses) deals their initial over-estimate a huge blow.

Governments ALWAYS under-estimate expenditures as EVERY program comes in over budget, over time and with layers of paid-for-life employees that add to the deficits forever. Not counted either as the magic Clinton trick of "balancing" a budget by removing future liabilities from your balance sheet. Not too mention NOT providing ONE cent of savings/investments to pay for them.

So, if the administration is predicting $9 trillion, expect $12-$15 easy.

And they have NO idea how bad EVERY policy coming out of Washington is going to REDUCE their tax revenues.

The little guys who used to pay over 50% of all taxes (state, local, federal) are dying on the vine. I personally know at least 20 businesses that will not survive one or two more increases in taxes/fees or new regulations and forced price increases.

We can't, the banks are taking our credit, our customers are sticking us in bankruptcies and competition with the third world is already killing us.

But hey, enjoy all those new free government handouts and "green" energy.

As long as it lasts, that is.

Aug 26 09:33 PM

[RatWatcher:]

Yessir. The gov separates 'Debt Held by the Public' (owed to bondholders) from 'Intragovernmental Holdings' (the SS Trust Fund, owed to retirees). The former is $7.4T and the latter is $4.4T. Add together you get $11.8T.

The trick is, the people who buy Treasuries (China, eg) don't care if we honor the SS Trust Fund piece. Debt to GDP is based only on the Debt Held by the Public figure.

The problem is, the gov is currently (massively) selling bonds to the public. That is what is and will continue to push the Debt/GDP ratio.

Here is a safe, government link that may explain better:

www.treasurydirect.gov...



On Aug 26 05:20 PM JJJ wrote:

> I keep hearing that our debt to Gdp ratio is around the 40% range
> from the CNBC talking heads, and that this latest revised 9 trillion
> 10 budget deficit will bring us near 80% debt to GDP. Just looking
> at our current national debt of about 11.3 trillion and a GDP of
> around 14trillion(rounded up), Isn't the debt to gdp ratio already
> above 80%(11.3t/14t)? Am I missing something here.

Aug 27 02:14 AM

[Zachary Sch...:]

AM chap - Good point. I'm not a big fan of cash and treasuries. Instead I think cutting back on risk means owning "stuff" or commodities. You can own physical gold and silver, you can own real estate, you can buy financial instruments that represent ownership in these areas. But the bottom line is that I want to be long hard assets and feel like that is a less risky play. Sure some cash is worth holding on to but as you say - the value of cash assets will likely decline over the next several years.

Jamesa - I don't think the consumer is anywhere close to having paid down enough debt to "not need bank financing." They may not GET bank financing but in order to spend, consumers either need to take much more time to pay down debt, or they will need to fund it with MORE debt.

The Geoffster - I'm not sure I get "trillion" and I'm a numbers guy! Do you think our elected leaders can get THEIR heads around "trillion"?

tunaman4u2 - see note to AM chap - owning hard assets appears the safest play to me

WheelsComin... - don't forget... WE are the traders too. We have to make money during this environment which sometimes means stepping back and waiting for the herd to exhaust itself and then picking up the spoils later.

inthemoney: - good point, well spoken

JJJ: - I'm not quite sure, but that's definitely worth looking at deeper. Your point however, is a good rebuttal to WAKEUP's two posts :-) Even though everything is bigger (an ode to inflation), it's bigger to a greater magnitude and alarming when considered as a percentage of GDP

TeresaE - You're right. It seems this administration has a grudge against anyone turning a profit. But in punishing those evil capitalists, we don't realize that we are punishing the entire country. Because it is successful business who actually create jobs. What will happen when we put all the strong companies out of business and rely on the government to supply jobs and stimulus? I sure don't want to rely on their programs to feed my family.

RatWatcher - Thanks for the link...

All - thanks for the great comments! Come visit zachstocks.com when you can. Lets keep the dialog going!

Aug 27 08:03 AM