Commentary

Federal Budget Deficit Kills Spring Fever

Spring is finally here after a long, frightfully cold winter. And with it comes the delusions induced by spring fever. Both the Obama administration and investors are stricken with the heady optimism associated with this illness, classifying the trickles of less than horrible economic data as green shoots that will bring America out of the nastiest recession since the 1930s. But, Monday’s news on the exploding federal budget deficit tossed icy water on the illusion that all is well on the economic front. It is now evident that the dismal state of the American economy is adding to the budget deficit by lowering tax receipts and blunting the efforts to cover new spending programs by raising taxes on the highest earners. The federal budget deficit for the 2009 fiscal year is now projected to be $1.84 trillion, equal to 12.9 percent of this tired nation’s GDP – which is a record high. This is the largest budget shortfall since the end of World War II.

According to an article in the NY Times released Monday, the Office of Management and Budget disclosed that since the last estimate two months ago, the recession heaped another $90 billion on top of an already staggeringly high deficit. The Times also pointed out that the Treasury’s new figures on the Obama administration’s plan to fund half the cost to overhaul of the health care system by limiting deductions for American plutocrats will come up $50 billion short.

But the Treasury quickly responded to this shocking dose of reality by making another outlandish claim: tightening the screws on recipients of large inheritances and altering the taxation of life insurance and assorted financial products for the well-heeled set would fill the new, larger gaps in the funding of the federal government’s sprawling operations. (Remember, Washington DC is now involved in running sizable chunks of the banking, insurance and auto industries.)

The Times said that Christina Romer, chairwoman of the Council of Economic Advisers, also came to the administration’s rescue by reaffirming sunny projections concerning the effectiveness of the gigantic economic stimulus package passed earlier this year. With eyes masked by rose-colored glasses, and a mind sprinkled with happy thoughts, Romer clung confidently to the fantasy that 3.5 million jobs would be rescued from oblivion or created out of thin air by the end of next year.

The reason that the Obama administration’s hopes will be dashed and investors’ wishes ignored is that this recession is unlike any experienced since the start of the Great Depression. This slowdown is not the result of the natural progression of the business cycle. Instead, it is the result of the bursting of a massive credit bubble, which had given rise to an orgy of debt-fueled consumption and an enormous housing bubble. And, unlike other recessions in recent history, a financial crisis quickly developed due to the reckless lending practices of America’s largest financial institutions.

In the field of rubble created after the credit bubble’s implosion, consumers are now wandering dazed and confused, saving instead of spending, and trying desperately to repair their swollen balance sheets. Companies that prospered during the bubble years are firing instead of hiring. And the federal government is pulling out all the stops to get the economy going again, building up an enormous deficit in the process.

The downsizing of consumer debt will take a long time, and the economy is in for several sluggish years before this process is complete. Just as consumers are saving more money, the federal government is spending it with reckless abandon to pump up demand in order to reestablish the economic status quo. Once the American economy does heal from the wounds inflicted during the credit bubble, the federal budget deficit will have to be brought under control. I believe that this will inevitably lead to one of two scenarios. The first entails higher taxes and lower government spending. The second, if the government ignores the call to act in a fiscally responsible way, will lead to competition with private companies for funding in the capital markets. The former results in less disposable income for consumers, the latter means higher interest rates and inflation. Neither outcome spells good news for the American economy in the years ahead.

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