FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
June 16, 2009

IN THIS ISSUE:

1.  Obama’s Unprecedented Spending Spree

2.  Obama’s Deficits To Double The National Debt

3.  Will The Markets Halt The Explosion In Debt?

4.  How Will Obama Fund His Massive Spending?

5.  Inflation Implications of Obama’s Spending

6.  Conclusions – Why Is He Doing This?

Introduction

It took the United States of America 233 years (1776-2009) to amass a national debt of $11 trillion.  Yet President Barack Obama’s record large 2009 budget deficit estimated at $1.85 trillion and his own spending plans for the next 10 years (2010-2019) show that our national debt will likely double over the next 10 years. 

Using the Obama administration’s own projections, the non-partisan Congressional Budget Office (CBO) estimates that, including the record 2009 budget deficit of $1.85 trillion, and huge annual deficits over 2009-2019 will result in an additional $11.1 trillion in national debt, on top of the current $11.4 trillion.  As I will discuss below, the national debt will very likely more than double in the next decade because some of the CBO’s economic assumptions may be too optimistic. 

As noted above, the CBO also recently revised its estimate for the budget deficit for fiscal year 2009 to at least $1.85 trillion.  But unless the economy rebounds soon, that number will very likely top $2 trillion by the end of September when FY2009 comes to an end.  According to the CBO, Obama plans to run a FY2010 deficit of apprx $1.4 trillion and almost $1 trillion in FY2011. 

Keep in mind that these deficits do not include even half of the massive costs for Obama’s health insurance plan, which some experts now project will cost between $1.5 and $2 trillion over the next 10 years.  Likewise, these projections do not include any money for the trillions that will have to be spent saving Social Security and Medicare over the next decade.

Whether you are a liberal or a conservative, these numbers should alarm you!  If the national debt doubles over the next 10 years, it will almost certainly be a disaster for the US dollar and the bond markets, and it will almost certainly wreck the stock markets as well.   The largest foreign holders of US Treasury debt are already expressing concern about Obama’s record spending, and they could abandon the dollar and US Treasury securities if the national debt rises 50% over the next five years, and doubles over the next 10 years, as is projected by the CBO.

This week, I will discuss the market implications of the national debt doubling in the next decade.  Let’s get started.  [Note: this week’s E-Letter will print longer than normal because I have included several charts and graphs.]

Obama’s Unprecedented Spending Spree

In just four months of his presidency, President Obama has shown he isn’t afraid to spend hundreds of billions of dollars on corporate bailouts or run up trillions of dollars in US debt in an effort to end the economic and financial crisis.  But in doing so, he has initiated the largest expansion of federal government since World War II and set up a massive challenge for his administration.

During the first 100 days of his presidency, Obama has signed the $787 billion stimulus bill into law, proposed an eye-popping $3.6 trillion federal budget for the 2010 fiscal year, taken over a massive $700 billion Wall Street bailout program (TARP) and created other multi-billion-dollar government programs supposedly to help grease the economic wheels.

In the wake of the economic and financial crisis, numerous respected economists and financial forecasters, including The Bank Credit Analyst and billionaire Warren Buffet just to name a couple, agreed late last year that the government should intervene with a large fiscal stimulus package to help rescue the US economy.  Many of these same sources wasted no time jumping onboard when Obama floated his idea of a near $1 trillion “stimulus package” earlier this year.

After some congressional tinkering, the final stimulus package came in at $787 billion.  While many argued that most of the huge stimulus should be spent in 2009 and 2010, President Obama strung it out over the next 3-4 years to fund his liberal programs, with relatively little of the money being spent in 2009 to jump-start the economy out of recession.

To-date as of late May, according to the Congressional Budget Office, Obama has only spent $37 billion of the $787 billion stimulus package this year.  Are you surprised?  Coming under increased scrutiny for not spending more sooner, Obama said last week that he is trying to accelerate the rate of spending of the stimulus money.  Whatever happens, this misses the point we should be focused on.

The point is, while many respected analysts agreed that a large stimulus package was needed in the short-term, they didn’t expect that President Obama would string-out the stimulus over four years with very little spent in 2009, plus continue to run trillion dollar annual budget deficits for several more years. 

Now that the economy is showing signs of a modest turnaround – with only $37 billion in stimulus spending – some are suggesting that Obama should rescind the remainder of the $787 billion stimulus package and save the money.  To that I say, fat chance!

Obama’s Deficits To Double The National Debt  

Along with the President’s request for a record $3.6 trillion budget for FY2010, he also submitted to Congress and the CBO his spending plans for the next decade.  These numbers shocked even many of those who initially supported the $787 billion stimulus package.  What follows are Obama’s projected annual deficits for FY2009 and the next 10 fiscal years according to the non-partisan CBO:   

TOTAL  $11.11 Trillion

http://www.cbo.gov/ftpdocs/100xx/doc10014/selected_tables.xls

You can confirm these huge budget deficits by the CBO at the link above.

[Editor’s Note: Obama promises to cut the deficit in half in four years, and the $658 billion projected deficit in 2012 certainly accomplishes that, but it is still $200 billion more than Bush’s record-large budget deficit of $458 billion in fiscal 2008.]

Where to begin?? First, these numbers should be staggering to anyone reading this, regardless of whether you are a liberal, a conservative or anywhere in between.  Second, if these numbers prove to be reasonably accurate, the United States will go from a national debt of $11.4 trillion today to $22.5 trillion by the end of FY2019.  As I will discuss below, it could be even higher.  This is unheard of!

If you add up only the first five years, 2009-2013, you find that the national debt explodes by almost 50%.  This unprecedented spike in the national debt will greatly exacerbate concerns on the part of our largest foreign buyers of Treasury debt, not to mention the downward pressure it will create on the US dollar and further upward pressure on interest rates.

If we look at the FY2009 deficit alone, estimated to be $1.85 trillion, we find that it equals 13.1% of GDP, according to the Congressional Budget Office.  That’s over twice the post-World War II record of 6% in 1983 under Ronald Reagan.

Fed Chairman Ben Bernanke testified last week that: “The ratio of federal debt held by the public to nominal GDP is likely to move up from about 40% before the onset of the financial crisis to about 70% in 2011.”   That puts the debt-to-GDP ratio at its highest level since the early 1950s, as a result of the huge debt buildup during World War II and just afterward.  The CBO projects that the debt-to-GDP ratio will soar to 82% by 2019.

In his House testimony last week, Bernanke added: “Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth.”  Of course, that comes from the head of the Fed which is in the process of buying up to $2 trillion in toxic securities and printing the money to pay for them.

Finally, to be fair, I must acknowledge that the current cycle of exploding debt began with George W. Bush.  In the latter years of the Bush administration, spending rose rapidly, while revenues remained reasonably flat.  Bush created an expensive new entitlement, the Medicare drug benefit ($63 billion cost this year), and let spending on many domestic programs run wild.  Over seven years, the wars in Afghanistan and Iraq added a total of some $900 billion to the budget. 

All told, Bush raised federal spending from 18.5% of GDP to 21%, setting in motion a chronic budget gap by piling on new spending without paying for it.  Long-time clients and readers will recall that I roundly criticized President Bush numerous times in these pages as he proved he could spend with the best of the Democrats. 

Yet Obama has elected to take spending and budget deficits to a whole new level.  Take note that Bush added apprx. $4 trillion to our national debt during his two terms, whereas President Obama is planning to add more than $11 trillion over the next decade.  Americans should not buy into the idea that President Obama is only spending this much because he inherited a recession and credit crisis from Bush. 

As Fortune magazine’s financial writer Shawn Tully wrote last week, “Under Obama the Bush trend keeps going, but this time on steroids.”  Doubling the national debt in a decade should be unconscionable!

As noted earlier, it is quite conceivable that the federal budget deficits could more than double, especially if Obama wins a second term as president.  Why?  First, the CBO projects that real GDP will grow by 2.9% in 2010.  I certainly hope they are right, but I doubt growth will be anywhere near that robust next year.  Second, the CBO projects that real GDP will grow by 4% in 2011 and 3.6% annually during the years 2012-2015.  You can view these assumptions at: http://www.cbo.gov/budget/data/econproj.xls

The latest CBO estimates also assume there will not be another recession between now and the end of fiscal 2019.  Granted, it is next to impossible to predict when the next recession will occur, but it is also a stretch to believe we won’t have one again for over a decade.

The bottom line is, these economic growth projections are very optimistic in my view and that of several other analysts I read.  Bond market maven Bill Gross of PIMCO fame agrees:

“The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have.” [Emphasis added, GDH.]

If real GDP does not grow by the CBO projections of 2.9%-4.0% in 2010-2015, then tax revenues will be lower than projected, and this will increase the annual deficits, unless spending is reduced accordingly or income taxes are raised significantly. 

Likewise, the CBO does not factor in any federal expenditures that would be required to overhaul Social Security and Medicare in the next 10 years.  Estimates on what it will take to make these agencies solvent in the years ahead vary widely, but most economists agree it will take at least $20-$40 trillion.

Thus, the national debt could easily increase by more than $11.1 trillion in the years 2009-2019, especially if President Obama wins a second term. 

Will The Markets Halt The Explosion In Debt?

It is my strong opinion that the markets will NOT sit by and watch the national debt soar by 50% in five years and double in 10 years.  In 2009-2011 alone, the projected deficits total $4.2 trillion.  That amount alone will, in my opinion, be more than enough to send the US dollar sharply lower.  And the dollar is already quite low as you can see in the chart below.  From its highs in 2001, the dollar lost apprx. 40% of its value before rebounding modestly beginning in 2008.

Note that since late February, the US dollar Index has once again rolled over to the downside and is trading around 80 as this is written.  If the dollar falls below the 2008 lows, I would expect another potentially powerful leg to the downside, fueled largely by the explosion in US debt and credible fears of rising inflation in our not-too-distant future.

With our major foreign lenders already complaining about buying US Treasury debt, a weaker dollar will only cause them additional concerns about rising inflation.  Ditto for rising US Treasury yields.  After falling significantly for the last several years, especially as the credit crisis unfolded, yields on Treasury securities have reversed sharply higher since the first of the year, much to the Fed’s dismay.

[Note: Treasury futures decline when yields go higher.]

The 10-year Treasury note yield, for example, almost doubled in recent months, rising from around 2% at the beginning of the year to near 4% as this is written.  Like the dollar, US Treasury yields are extremely sensitive to inflation expectations.

Adding to the problem is the fact that the largest foreign buyers of US debt are notably concerned about the trillions Obama plans to spend and the likelihood that it will lead to higher inflation in the US.  China has recently called for the yuan to replace the US dollar as the world’s reserve currency.  That won’t happen anytime soon, of course, but it certainly indicates the level of discomfort among the major foreign buyers of our debt, which include:

Source: U.S. Treasury Dept. as of March 2009.

Obviously, if the dollar resumes its bear market, and Treasury yields continue to rise, this will raise even more concerns among foreign lenders regarding higher US inflation down the road.  In addition, this will not only hamper the modest recovery from this severe recession, but could also throw us back into a new recession over the next few years as Obama increases the national debt by $4.2 trillion in 2009-2011 alone.

How Will Obama Fund His Spending
If The Markets Force His Hand?

If the markets respond to Obama’s enormous increases in spending and budget deficits as I fully expect they will, he will have to resort to other measures to fund his record large spending plans.  Here are some examples of how he may attempt to do so.

During the campaign and since taking office, Obama has promised to raise taxes only on those Americans making $250,000 a year or more.  For those making $249,999 or less per year, he has promised to leave in place former President Bush’s tax cuts.  But the math doesn’t remotely add up.

Numerous recent studies have shown that if Obama wants to cover his spending plans by raising taxes only on those making $250,000 a year or more, he would have to raise their tax rate to at least 60%.  That is not likely to happen (or so I would presume).

Facing the projected annual budget deficits from the CBO discussed above, Obama will have little choice but to renege on his promise not to raise income taxes on the middle class in the next year or two if the economy does not rebound robustly.  I will go on the record and predict that Obama will repeal the Bush tax cuts on the middle class by 2011 if not sooner.

Yet even that will not come close to covering Obama’s massive spending plans in the next few years.  On this point, conservatives and even many liberals agree, including liberal maven Paul Krugman, a leading columnist for the New York Times.  Krugman is urging Obama to raise income taxes on both the wealthy and the middle class.

The Obama administration clearly understands that its spending plans will lead to huge deficits in the future.  Yet President Obama refuses to admit publicly that his spending plans will double the national debt in 10 years, as the CBO has projected, and he is reluctant to break his promise and raise taxes on the middle class (although I believe he will by 2011 at the latest).

Another option President Obama and Congress are now considering is a European-style “Value-Added Tax”(VAT) that will increase costs to ALL Americans for the goods and services we buy.  Space does not permit me to go into all of the details of a VAT tax, but suffice it to say that additional federal taxes are levied on goods and services at various levels in the production process before these products and services are offered to the public.

In my opinion, the VAT tax is the most egregious way for politicians to raise taxes in an effort to deceive the public.  Yes, the informed public will know exactly what is happening with a VAT tax, but many taxpayers will simply see it as the continual rise in the prices of goods and services due to inflation, and not as the result of an increase in taxes.

For over two decades, the VAT tax has been discussed only in the context of an alternative to our current progressive income tax system.  The discussion has been, if we implement the VAT tax (or a national sales tax), we could eliminate the current income tax.  Never before now has a VAT tax been discussed in addition to the current income tax.  But it is on the table now!

Obama’s press secretary said last week that a VAT tax is not on the table now, but others in his administration have admitted that it has been discussed.  Congress is already considering a VAT tax openly.  I will not be surprised if Obama and Congress try to implement a VAT in 2010 or 2011, especially if the markets react as I suggested above.

Inflation Implications of Obama’s Spending

Over the years, many clients and readers have asked me how and why we have had spiraling inflation at various times over our history.  The textbook answer is that inflation rises when too much money is chasing too few goods and services.  Too much money chasing too few goods is far too simple an explanation in today’s incredibly complex financial world.  Yet the basic premise is still true. 

The Federal Reserve controls the money supply, and the money supply has skyrocketed over the last 18-24 months as the credit crisis has played out.  Yet because of the severe recession, because consumers are spending less and saving more, and because home prices continue to implode, the dramatic rise in the money supply has not sparked higher inflation.  In fact, deflation has been the greater threat over the last 18-24 months.  

For the reasons noted above and others, the Fed has had the ability to pump up the money supply by a record amount over the last 18-24 months without generating sharply higher inflation.  But most economists and financial analysts agree that at some point the Fed must remove some of this liquidity and increase interest rates or else inflation will begin to rise, perhaps significantly.  This is part of the reason why Treasury yields have jumped recently.

As you can see in the chart below, commodity prices are already on the rise.  The CRB Index represents a basket of traditional commodities (grains, meats, metals, sugar, cotton, rubber, etc.), and this index has jumped apprx. 20% just since mid-March. 

Interestingly, the CRB Index does not include crude oil, heating oil or gasoline.  As we all know, crude oil prices have surged from $35 a barrel in mid-February to above $72 a barrel last week. The national average price for a gallon of gasoline was over $2.60 last week according to the Dept. of Energy, and has risen over $1 per gallon since the first of the year.

So, it is clear that the seeds of higher inflation have been planted.  But because the recession is likely to continue at least another quarter or two, I don’t expect inflation to spike higher anytime soon.  However, the Fed faces some very difficult choices in the second half of this year as the economy shows more signs of recovering.

Conclusions – Why Is He Doing This?

Based on the Obama administration’s own spending projections, the non-partisan Congressional Budget Office projects that the US national debt will almost double by 2019.  It will increase by 50% in the next five years alone, as Obama runs trillion dollar deficits for several years.  The CBO now estimates that the fiscal 2009 deficit will be a whopping $1.845 trillion, and it could be even higher.

Fed Chairman Ben Bernanke warned that the US debt-to-GDP ratio will soar from 40% to 70% between now and 2011 as Obama records trillion dollar deficits.  The CBO projects that the debt-to-GDP ratio will soar to 82% by 2019.  Sadly, all of these numbers could come in even higher if the CBO’s economic assumptions prove to be too optimistic, as I believe they will.

It is my belief that the US dollar will plunge, and bond yields will rise sharply if Obama insists on running trillion dollar deficits for the next several years. If so, the president will have to resort to raising taxes on not just the “rich” but the middle class as well.  It may come in the form of a “Value-Added Tax” which will raise taxes for everyone.  We’ll see.

The commodity markets are signaling that higher inflation lies ahead.  Maybe not in 2009 but it will almost certainly happen if Obama runs trillion dollar deficits for the next several years.  We will see if the Fed can keep inflation under control.  I doubt it unless the Fed is willing to risk another recession in late 2010 and 2011.

At the end of the day, the question is, why is President Obama willing to risk so much in order to spend record amounts of taxpayer money?  I will leave that question for others to ponder.

Likewise, I have not opined in this letter as to Obama’s push to get his health care “reform” program passed as soon as possible.  However, there is a very good article on the subject in SPECIAL ARTICLES below.  

Finally, I rest assured that I will get blasted by readers who are Obama supporters as a result of this E-Letter – I always do when I write anything negative about him.  But as noted earlier, doubling the national debt in 10 years (or possibly less) ought to concern ALL Americans regardless of their political persuasion.  If you agree, feel free to let me know.

That’s all for now. 

Wishing you a great summer,

Gary D. Halbert

SPECIAL ARTICLES

The Beginning of the End of Private Health Insurance
http://www.reason.com/news/show/134016.html

A Red (Ink) Letter Day For Gov't: $1,000,000,000,000 In 8 Months
http://www.ibdeditorials.com/IBDArticles.aspx?id=329442095812782

Bonds – What Goes Up Must Come…
http://www.washingtonpost.com/wp-dyn/content/article/2009/06/15/AR2009061502710.html

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