Increased Deficit Spending: We Can't Afford It

Includes: DIA, QQQ, SPY
by: Zachary Scheidt

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.