It’s an old story, but it’s getting worse and so ignoring the 800-pound elephant in the room is getting tougher by the month.
Deficits and debt are mounting and changing the trend won’t be easy. We can debate if the U.S. will muster the intestinal fortitude necessary to even slow the pace of red ink’s ascent, much less reverse it. But in terms of absolute and relative levels of debt on the country’s balance sheet, the future looks assured, as a growing chorus of observers warn.
That includes a fresh advisory from the St. Louis Fed. The title says it all: Deficits, Debt and Looming Disaster: Reform of Entitlement Programs May Be the Only Hope. “For the fiscal year 2008, the federal government’s deficit totaled $455 billion, the largest ever for a single year,” Michael Pakko, an economist at the bank, writes. “In the final days of the fiscal year, which ended Sept. 30, the total federal debt rose above $10 trillion for the first time.”

To put the numbers in perspective, a chart from the article is illuminating, albeit in a grim sort of way. As a percentage of GDP, federal debt is roughly at the depths reached in the 1980s, the last time that such fiscal worries were front and center. Given the incoming Obama administration’s plans to spend, spend, spend, it’s a safe bet that when all the budgetary dust clears, the debt troubles of 20 years ago will pale by comparison.
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Yes, there’s a strong case for arguing that what this country needs (again) is a good $800 billion (stimulus) cigar. This writer and many others have warned frequently over the past several months that as troubling as a spending spree is at this point, the alternative—deflation—is worse. Unfortunately, the only way to prevent deflation at this point is to shovel money into the economy, as we’ve discussed. We’d prefer another choice, but engineering a different scenario required different policies in years past. But having let the fiscal burden grow, we’re now between the rock and the hard place with the deflationary winds blowing directly in our collective faces. Simply put, this is no time to balance the budget.
Yes, we as a nation should have been focused on that goal in years past, when the economy was growing and deflation was nowhere in sight. Oh, well. That was then and this is now.
The deficit and debt troubles are old news, of course. Countless observers of the economic scene have long been warning of the challenges that will eventually come home to roost if we don’t amend are spendthrift ways. A year ago, yours truly contributed to this genre of essays and penned an article more than a year ago by the name of “The $64 Trillion Question: Is the long-term budget outlook really a ticking time bomb—and does the Federal Government need a financial advisor?” A dark bit of reporting, to be sure, but revealing just the same.
The sad news is that the outlook has continued to worsen since the article was published, and more of the same is on tap for the foreseeable future.
The St. Louis Fed piece sums up the primary challenge in all of this by advising that “the long-term fiscal outlook for the U.S. requires serious attention. The retirement of the Baby Boom generation and a slowing rate of growth in the labor force will create a demographic time bomb in which entitlement growth threatens to swamp available resources.”
You don’t need an advanced degree in economics to recognize that the promised future liabilities of the U.S. look unsettling. Ultimately there are only so many fixes. One is cutting spending, which means pulling away the government’s promises to some degree on, say, Medicare and Social Security. Good luck with that one.
Then there’s the old standby of raising revenues with higher taxes. Ideally, that would be funded by a surge in economic growth. Otherwise, the task becomes more politically risky. Nonetheless, raising taxes looks a bit more likely, perhaps even inevitable, relative to the prospects for cutting services. Even so, it’ll be a while before anyone’s brave enough to talk up that idea, at least among the politicians running the show these days. Indeed, in the current climate, President-elect Obama is now the leading advocate for tax cuts, as Bloomberg News reports.
Another solution, if you can call it that, is to inflate our way out of the problem. As history suggests, that’s the usual path, in part because it’s subtle and politically easy. No one ever votes for higher inflation; it just sort of happens and—surprise, surprise—everyone’s shocked.
As we write, that’s just what we’re doing. Big time. Spending is the only game in town. But it has consequences. It always does. Indeed, there are any number of implications for investors given the fiscal outlook. Economist David Hale discusses an obvious one in today’s FT: “Precious metals could emerge as a hedge for investors suspicious of central banks and fearful that inflation will be the simplest solution to the challenge of global deleveraging.”
The flip side of that advice is worrying about Treasuries. In a world where the printing presses are running flat out, and interest rates are at record lows, the future for Treasuries, which posted powerful rallies last year, looks shaky. No wonder, then, that Barron’s advises to “Get Out Now,” warning that Treasuries are in bubble territory.
Summing up, deflation first, followed by inflation. Details on timing to be determined. Next question.