Daily Investment Interpretations

November 8, 2009

2009-11-8: The Federal Deficit
    During the 1990's, the federal national debt was the great doomsday theme. The  national debt kept growing and growing and growing, and everybody knows that you can't just keep running up your bill and running up your bill. You've got to pay it off. That's what you and I would have to do isn't it? "We're headed for the biggest crash in the history of the United States in the year 2000, and for only $199 a year (a $100 discount from my regular price of $299 a year, but only if you act on this before midnight tomorrow), I'll tell you how to survive and even prosper during the cataclysmic national debt crash that's coming in the year 2000." This was one popular way the financial con artists played the investing public in the 1990's.
    Of course, unlike you and me, governments can and do keep running up their budget deficits without ever paying them off. What counts is the ratio of the national debt to the gross national product, coupled with other factors such as low interest rates so that the governments don't have to pay high interest rates on the long bonds they sell. For example, the U. S. national debt in 1945, at the end of World War II, was $259 billion, and the U. S. gross domestic product was $223.2 billion, leading to a 1.16 ratio of national debt to gross domestic product.
    Today, the national debt is, as of tonight, $12 trillion, and the trailing gross domestic product is 14.3 trillion, leading to a ratio of 0.84. But note that the absolute value of the national debt has ballooned from $259 billion to $12 trillion over the past 64 years. It's not the absolute value of the national debt that counts but the ratio of the national debt to GDP. (To put it in personal terms, if your income octuples, you can afford a much bigger home loan than you could before that happened.) And as long as countries pay the interest on their national debts (and they print their own money), they can continue to carry the loans without paying them down or paying them off.

 The Real Cost of Fiscal Stimulus:
    I'm going to assume that  a recession has occurred, and that the GDP (Gross Domestic Product) after a year of slowing, and then slightly declining GDP (currently running about $14 trillion a year), the GDP has fallen behind what it would be at full growth by $1 trillion. This loss is permanent no matter what the government does or doesn't do to stem further losses. The horse is already out of the barn. 
    Suppose the U. S. government injects $1 trillion into the economy (which it approximately has done) by selling Treasury bonds and adding another $1 trillion to the federal deficit. According to Paul Krugman, federal taxes will return about one-third of this $1 trillion stimulus insertion or about $333 billion to the government within the next year or two. That leaves a net cost of $667 billion. But what we want to know is: what would the recession do to the national debt if the government didn't inject a $trillion into the economy? Recessions cut tax receipts at all levels of government: federal, state, and local. Recessions force the federal government to add to the national debt in order to keep federal programs running. At $2.7 trillion a year, the federal budget runs about 20% of the annual $14 trillion GDP. So a $1 trillion shortfall in the GDP below its rising trend means $200 billion less in federal tax income.
    Note that the kind of loan the U. S. government is taking out isn't like borrowing money for a vacation trip. It's more like borrowing money to invest in your business. The government expects its $1 trillion investment to boost its future income much more than enough to offset the $1 trillion it's investing, as discussed below.
    I need to underscore that what follows below is my own guesstimation and it may be seriously wrong, but at least, it gives a quantitative model for the fiscal stimulus. 
    From 1999 to 2006, the GDP (Gross Domestic Product) has grown at a rate of about 5% a year... 2% real growth per capita plus a 3%-per-year rate of inflation*
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* - The rate of growth of the GDP between October, 1947 and October, 2006, was about 6.73% a year. The real rate of rise over this 59-year period after correcting for inflation was about 3.68% a year.
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    Table 1., below, shows in the second ("Projected") row, the projected GDP if GDP growth had continued at its 1999 through 2006 growth rate of about 5% a year. 
    The third row ("Actual and/or Estimated") shows actual and projected values of GDP from 2006 through 2010. I'm assuming that the economy makes a robust recovery, and by 2012, has caught up with where it would have been if there had been no recession (which may be too optimistic, especially considering the fact that a portion of the gains since 2003 have been fueled by ever-deepening debt).
    The fourth row ("Shortfall") shows the amount which the recession costs the economy each year.

Table 1. -  The Best-Case Scenario: A $1 Trillion Fiscal Stimulus

    Table 1. represents a best-case scenario. It assumes that the government has pumped $1 trillion into the economy, and that this has been sufficient to cause the economy to recover. I've assumed that the economy accelerates sufficiently rapidly in 2011 and 2012 to bring it back up to its trend line by 2012. For 2011, I've interpolated between an official projection for 2010 ($14.4 trillion) and the trend line projection for 2012 ($18.52 trillion). 
    This scenario leads to a total shortfall (loss) to the economy of $6.58 trillion. and would lead to a $1.32 trillion increase in the national debt.

(To Be Continued)