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Obama Budget Adds $9.5 Trillion to US Debt |
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FORECASTS & TRENDS E-LETTER
IN THIS ISSUE: 2. Dallas Fed Chief Warns US is at a Debt “Tipping Point” 3. Enormous Spending Cuts Required to Balance Budget 4. Do Americans Really Want Serious Spending Cuts? Introduction On March 18, the non-partisan Congressional Budget Office released its annual “re-calculation” of President Obama’s 10-year budget proposal that he released in February. The CBO now estimates that Obama’s budget proposal will add $9.5 trillion to the national debt over the next 10 years, if enacted. The latest figures project the national debt to increase by more than $2 trillion above what the White House put out in its forecast last month. My readers were not surprised, however, because in my February 22 E-Letter, I showed you that Obama’s 10-year “adjusted baseline” deficits added up to $9.4 trillion. Now the CBO says it will be even higher than the totals I showed you last month. Even the CBO’s latest estimates are likely to be too optimistic as well. For example, both the President’s and the CBO’s budget estimates assume that there will not be a recession in the next 10 years, and both include interest rate estimates that are probably too low. Today we will take a look at the latest budget numbers from the CBO. Like a lot of other analysts, I don’t believe that it will be remotely possible to add almost $10 trillion to the national debt over the next 10 years. The bond market won’t stand for it, much less the foreigners that own almost 50% of our national debt held by the public. If we continue down this path of runaway debt, another even larger financial crisis is coming our way sooner or later. On that note, Dallas Federal Reserve Bank President Richard Fisher warned last Tuesday that the next financial crisis will may be coming soon. Fisher noted that the US is now at a debt “tipping point,” and he urged Fed Chairman Bernanke and other members of the Fed not to concoct another QE3 when the current QE2 ends in June. That raises questions about what will happen when QE2 ends, assuming that it is the end of the line for massive Fed purchases of US Treasury debt. I will also offer some thoughts on that topic in the pages that follow. Finally, I will follow up on a topic I also focused on in my February 22 E-Letter. Many Americans say they want government spending cut; that theme was clear in the 2010 mid-term elections. But do they really? Some recent polls shed some interesting (disappointing) light on that subject. That’s a lot to cover in one letter, so let’s get started. CBO: Obama Budget to Add $9.5 Trillion to National Debt Each year every president produces a 10-year federal budget forecast. Every year they include assumptions that are probably too optimistic. Every year the CBO re-calculates these budget forecasts using its own assumptions for such things as GDP growth, interest rates, etc. Obama’s budget forecast last month was not the first to come in with lower deficits than the CBO. But no budget EVER has added $9.5 trillion to the national debt in 10 years! In its report on March 18, the CBO released the following table. Before you peruse it, the only number you need to look at is on the far right side of the page in the middle section entitled CBO’s Estimate of the President’s Budget, under the heading of Deficit,and the highlighted number is -9,470 ($9.470 trillion).
$9.470 trillion is what the CBO believes will be added to our national debt if Obama’s 10-year budget proposals are enacted. They won’t be, of course, because Obama won’t be in office for 10 years. And I think the bond market would implode well before that could happen, not to mention an exodus on the part of foreign buyers of our debt. On that note, the latest CBO deficit report also concluded that Obama’s budget projections would require the portion of the national debt held by foreign investors to more than double during the next decade. But does anyone really believe that foreigners are going to stand by and watch as we add another $9.5 trillion to our national debt in just 10 years? I don’t think so! Dallas Fed Chief Warns US is at a Debt “Tipping Point” The President of the Federal Reserve Bank of Dallas, Richard Fisher, is one of the most hawkish (read: conservative) members of the Fed Open Market Committee, which makes monetary policy decisions. Fisher was not a fan of the Fed’s policy of “Quantitative Easing” and is openly urging Fed officials to end the policy when QE2 is over in June. Speaking at a conference in Frankfurt, Germany last Tuesday, Fisher offered a particularly chilling warning to the attendees. Fisher said that he believes the US is now at a debt “tipping point” and urged the US central bank to refrain from any further stimulus measures. He said:
Fisher believes that the US economic recovery has now reached the point that no further QE is warranted, and that any further stimulus would come with a risk of higher inflation before long. As such, he is lobbying his fellow Fed members to call it quits when QE2 ends in June. He went on to say:
Clearly, this is a controversial and possibly risky position for Fisher to take, since his boss, Fed Chairman Ben Bernanke, has been the architect of QE from the beginning. But Fisher has always spoken his mind, even if he didn’t agree with the Fed Chairman. That’s why he is my favorite Fed bureaucrat. Fisher’s prediction that the US is at a debt “tipping point” is a stark reminder that we may be approaching the time where foreign investors refuse to buy our Treasury debt, or even start unloading it. He is clearly very concerned, and I believe he is correct. While Fisher is openly advocating an end to QE in June, at the risk of his job, it remains to be seen whether or not Chairman Bernanke agrees. All of this leads to the question: What happens if the Fed doesn’t enact QE3 when QE2 ends in June? Since last November, the Fed has been buying long-dated Treasuries at the reported rate of apprx. $75 billion per month. Bernanke’s stated goal for these purchases was to lower interest rates to help stimulate the economy. As you can see from the chart below, bond yields have actually gone higher since the Fed started QE2 late last year. While yields have fallen somewhat since mid-February, they are still significantly higher than the lows last fall. Clearly the Fed’s goal of lowering rates did not work. But one can argue that were it not for QE2, bond yields would be even higher, and that could be true.
It remains to be seen what will happen when QE2 ends in June and whether or not the Fed will enact QE3. I think the Fed will cease purchases in June and then wait a few months to see how things go. There was nothing in the Fed Open Market Committee policy statement on March 15 to suggest that it will enact QE3 when QE2 ends in June. As for bonds, I would not be surprised to see yields move even higher, both because of the halt in Fed purchases in June and because inflation pressures are building. The last time the Fed halted purchases (QE1), the S&P fell by 12.6%, and oil and commodity prices fell sharply (gold being the exception, of course). Whether or not that will happen again this time is unknowable. Enormous Spending Cuts Required to Balance Budget Most political observers agree that the mid-term election results last November were a mandate by voters for President Obama and Congress to get serious about cutting spending, and I would agree. Yet it remains to be seen if the Republicans in the House will be successful in cutting spending significantly in the next two years. Let’s face it, cutting $61 billion or even $100 billion does NOT qualify as “significant” cuts in spending, especially if the federal budget is $3.7 trillion as President Obama requested for FY2012. Let’s also face the fact that it will be virtually impossible to balance the budget without cutting entitlements. Take a look at Obama’s federal budget for FY2012:
If you include interest on the national debt, mandatory spending is 65% of the proposed budget, leaving only 35% in discretionary spending. In order to come close to balancing the budget, there would have to be draconian cuts in discretionary spending that, quite frankly, I don’t think the Republicans and certainly not the Democrats are willing to make. In my February 22 E-Letter, I posited a theory that while Obama heard the message of the mid-term election “shellacking” as he put it, he doesn’t think the American people really mean it. So he continues to spend with abandon and run record deficits ($1.65 trillion this year), and still believes he can get re-elected in 2012. Big gamble, in my opinion! But what if President Obama and his inner circle are correct? Is it possible that most American voters say they want government spending slashed, but not if it negatively affects them? I certainly don’t want to believe that! However, several polls taken earlier this month raise some serious questions. Let’s take a look.
Do Americans Really Want Serious Spending Cuts?
On March 21, Gallup issued its latest survey of public concerns, and the economy remains at the top of the list, with 71% reporting that they worry about it “a great deal.” The budget deficit/federal spending was a strong second, at 64%. Notably, there is a wide gap between Democrats and Independents on this issue: While Independents rank spending/deficits second on their list, behind only the economy, these spending/deficit issues don’t appear at all on the Democrats’ list of top concerns. The latest Pew Center surveys also underscore that the importance of cutting spending is atop the minds of Americans, but endorsing a serious remedy is quite another. By a margin of 2 to 1, the public favors cuts in domestic spending. Yet that’s where the widespread support for fiscal austerity ends. On how we cut spending, the country is deeply divided. For example, Americans are split down the middle (47% in favor, 49% opposed) on cutting defense/military spending. More importantly, Americans reject changes to Social Security and Medicare by 65% to 30%. And they oppose raising taxes by a similar 67% to 30%. Compared to six years ago, support for cutting discretionary spending, domestic and military, has risen significantly, while opposition to tax increases hasn’t budged. In some cases, these sentiments cross party lines. For example, 75% of Democrats oppose cutting Social Security and Medicare, but so do 61% of Independents and even 59% of Republicans. Even in today’s debt crisis, almost 60% of Republicans still oppose cutting entitlements. That surprises even me! On another front, 76% of Republicans oppose tax increases, as do 67% of Independents and 61% of Democrats. Democrats opposing tax increases by 61% seems way too high to me, but that’s what the latest poll showed. 71% of Republicans favor cuts in domestic spending, but so do 60% of Independents and even 54% of Democrats (also surprising to me). The only area of significant disagreement is defense/military spending, where 57% of Democrats and 52% of Independents favor cuts, compared to only 33% of Republicans. Conclusions As noted above, no serious federal budget analyst believes that we can regain control of our fiscal future solely through reductions in discretionary spending. The Gallup and Pew surveys noted above make it clear (if further evidence was needed) that public concern about our spending/deficit problem far outruns public understanding of its sources and scope. As I have argued often, the only way to change these public attitudes is to level with the people about our dire fiscal situation and educate them about the true choices we face. The American people need to understand that we have to cut both discretionary spending and entitlements. This task is essential and long overdue. If we don’t get a national understanding of the serious spending dilemma, we will face another even worse financial and economic crisis that will dwarf the Great Recession of 2008. I can’t stress enough the risk that the bond market will collapse and foreigners will exit US Treasury debt in droves at some point if we don’t change our ways. Normally, we look to our president to guide us in times leading up to a major crisis. But our current president apparently doesn’t believe that runaway spending and trillion-dollar deficits are any real problem. Otherwise, why would he propose to add $9.5 trillion to our national debt over the next 10 years? I find that hard to believe as there is no doubt that Obama is a very smart man. What we have to keep in mind is that, while Obama is very smart intellectually, he has a very liberal, big government ideology. He apparently subscribes to the old theory that the ballooning national debt is no problem because we “owe it to ourselves.” That was then, this is now. Some 70-80 years ago, most of our outstanding debt was held by American interests. But as noted above, today foreigners own almost 50% of our outstanding publicly-held federal debt, and they can unload it at any time they wish. President Obama also apparently subscribes to the theory that foreigners won’t unload our debt because they have no other good place to go. History is strewn with political leaders who believed that. Rarely were the outcomes positive. I think Obama is a good student of history. Given that, some political observers wonder whether Obama wants the US to fall into a serious economic/financial crisis. While I can’t rule that out, I believe he is merely a Keynesian who does not believe it is possible for the government to spend too much. In any event, I’ll have to leave that controversial topic for another time. The bottom line is that the US faces some daunting challenges in the next few years. The problems we face pose some critical risks in the investment markets where we all have our money and retirement savings on the line. While the stock and bond markets have delivered some impressive gains in the last couple of years, the downside risks are clearly increasing by the day. Since I try not to be too depressing, I’ll leave it there for this week. I do not want to be a Gloom-and-Doomer, but these are serious concerns that we all need to keep in mind. Finally, if you like what you read in my weekly E-Letters, feel free to forward them to others, or better yet, have them subscribe to get it automatically at http://www.forecastsandtrends.com. They are free of charge, as you know, and you always have our promise that we will never share your e-mail address with anyone, so feel free to forward as you wish. And most importantly, I always welcome your comments and suggestions, positive or negative. Your feedback helps me to know where your interests are and with topic selection, so please keep them coming. A Final Note on Japan Our hearts and prayers go out to all of the Japanese people that have lost loved ones and seen others badly injured in the wake of what many are calling the worst disaster ever. The news from Japan seems to get worse with each passing day. While I have no doubt that the Japanese will recover from this catastrophe, they can sure use our help. Think about giving to the Red Cross or your favorite charity that can direct funds to good use in Japan. I don’t know all of the ramifications of the disaster or how it may affect us here in America, but here is a brief analysis by the economists at Wells Fargo that was posted yesterday:
FYI, the economists at Wells Fargo publish a regular report entitled Weekly Economic & Financial Commentary which comes out every Monday. It’s a fairly short and sweet economic analysis with charts and graphs, and best of all, it’s free. You can find it on Mondays at http://www.realclearmarkets.com. I think you’ll find it useful. Here’s a link to yesterday’s issue: http://www.realclearmarkets.com/blog/WeeklyEconomicFinancialCommentary_03_25_2011.pdf Very best regards,
Gary D. Halbert SPECIAL ARTICLES
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