Arnold and Ed on Infrastructure Investment: Good Idea, Bad Plan

Includes: BFZ, EIP, UDN, UUP
by: Bruce Krasting

California’s Governor (NYSE:R) Arnold Schwarzenegger and Pennsylvania’s Governor Edward Rendell (NYSE:D) were on TV Sunday. These two were having a bi-coastal love fest. They have connected with another big shot, Mike Bloomberg, in an effort to steer the country toward a much larger program of infrastructure investment.

This is an old story. You don’t have to look too far to see that America is in need of some new ‘stuff’. They made the case that other countries are investing more than we are and as a result we are falling behind. Arnold made a good point when he said that the US was spending 5% of GPD on infrastructure in the 60’s and that paid off for decades. The current infrastructure investment rate is only 2.5%. The Cali Governor made it clear, the nation should revert back to that 5% level. It would create jobs today and the investments would pay off in the future with more jobs. Ed R. was almost slavering about all the steel his state could produce under those conditions.

This sounds good. But it is a dead end. A 2-1/2% increase in infrastructure spending translates to $350b a year, for at least the next five. With interest that comes to $2 trillion. Call it an extra $30 billion a month of funding requirements. That would of course be on top of the existing deficit. What is already on the table comes to about $120b a month. Forever. These two governors want us to go into hock for an addition 25% over our existing crazy monthly nut.

The Terminator gave an example of his thinking. He is planning a new $11b bond to cover the cost of a major irrigation project. There are clear benefits to the proposal. But another $11 of debt is required. The solution to Cali’s problem is obvious. Borrow, spend and worry about paying it back later. At one point the bond market will just say “no”.

Ed. R. made his thoughts on deficit financing clear. His message was, if we don’t borrow and invest “We will become a second rate power”. The T added: If we don’t rebuild our infrastructure, “We will fall like Rome”.

QE interest rate management is over. We will be moving to more normalized rates over the next few years. If one takes the Fed at it’s word they will be unwinding their emergency measures. They are not going to be a buyer of incremental debt. The macro economic conditions are not producing the big current account imbalances that led to the foreign demand for our debt. The recent increases in holdings by the UK, Japan and Hong Kong are not sustainable. A historically big buyer, the SS Trust Fund bought half as much as they did in 2009 than in 2007. In three or four years they will begin selling their big holdings. As for those savers in the US, well they might pick up some of the slack. But not at the interest rates being offered today.

At the moment the US is benefiting from a global capital move to what is perceived to be dry land. That trend may well continue for some time. But at some point the pendulum will swing the other way and the capital will leave our relative safety. (Someone please show me who (major category-$100b per annum) is going to absorb the coming $5-8 trillion of supply?)

Ed and Arnold probably have it right. If we don’t borrow and spend we will become a second rate power. The problem that I have is that if we spend and borrow as much as is being suggested we will most certainly fall like Rome.