Thursday, May 21, 2009

When to plug Fed's flow?

By Tom Raum • The Associated Press • May 17, 2009

This item appeared in the Cincinnati Enquirer

WASHINGTON - The federal government has committed trillions of dollars to domestic bailouts and propping up the recessionary economy, much of it borrowed, much created out of thin air by the Federal Reserve.

How much longer can all this go on? That's the pressing question facing policymakers, and one without a clear answer.

At some point, "You have to take away the punchbowl, as someone once said, in order to avoid the inflation risk," said Federal Reserve Chairman Ben Bernanke, paraphrasing William McChesney Martin Jr., who served as Fed chairman in the 1950s and '60s under five presidents.

But change course too soon, and it could nip a fragile recovery in the bud. Wait too long, and runaway inflation and gargantuan federal debt could be the sequel to the worst downturn since the 1930s.

While nobody thinks the current combination of near-zero interest rates, bank and auto bailouts and trillion-dollar annual deficits is a sustainable economic model, knowing just when to take away the punchbowl is the problem.

For now, the Bernanke Fed is still filling the punchbowl. And President Barack Obama and the Democratic-controlled Congress are doing the same with government spending.

One reason the Fed has been so aggressive in slashing rates and taking unconventional recession-fighting steps is because "we are trying to avoid another form of price instability, which is deflation," Bernanke told a Fed financial conference last week.

The risk of deflation - a widespread and prolonged decline in retail prices, wages and real estate and other asset values - is "receding, but it certainly needs not to be ignored," Bernanke said.

Despite some recent glimmers of hope, evidence is mixed on whether things are getting better or still worse. Disappointing reports Wednesday on falling retail sales and a jump in foreclosures fueled continuing uncertainties and helped push stocks down.

"You've got to take the stimulus off at some point. I don't think that point is this year," said David Wyss, chief economist at Standard & Poor's in New York. He said Wednesday's reports on weak retail sales for April point to a continuing recession, despite some recent encouraging signs.

Government and most private economists expect the recession, which began in December 2007, to end later this year, although they expect high levels of joblessness to continue beyond.

In the meantime, recent developments are complicating efforts to tame the deficit once the recession does end:

White House budget officials said recently that the deficit would widen to a record $1.8 trillion this year, $89 billion more than their estimate in February. They blamed the recession.

With nearly 80 million baby boomers nearing retirement, the government reported that Medicare and Social Security will face insolvency sooner than previously projected because of the recession - for Medicare in 2017 and for Social Security in 2037.

A potential $90 billion shortfall opened up in paying for Obama's health care proposal. The gap comes from congressional reluctance to go along with his proposal to help pay for the plan by limiting high-income families' charitable-giving and other tax deductions. House Speaker Nancy Pelosi said the health care bill will be on the House floor before the August recess.

The administration asked Congress on Tuesday to add $100 billion in new U.S. contributions to the International Monetary Fund as part of a war-spending bill.

Obama proposed just $17 billion in new spending cuts earlier this month, representing savings of less than one-half of 1 percent in his $3.4 trillion budget. Republicans scoffed - and some top Democrats criticized him for targeting popular programs in recessionary times.

By some accounts, the sum of all the U.S. grants, loans, guarantees and new money created electronically by the Fed since the financial crisis began totals some $11 trillion - roughly equal to the country's national debt.

That sum does include loan guarantees that might not be needed, money that hasn't been spent, various revolving accounts and U.S. investments in bad mortgages and other toxic, hard-to-value securities that could someday return money to taxpayers. Still, staggering amounts are involved.

"We are creating a government debt bubble that we're going to have to deal with in a massive way," suggested Rep. Kevin Brady of Texas, the senior Republican on the Congressional Joint Economic Committee.

History shows the dangers of calling the end of economic downturns too soon.

President Franklin D. Roosevelt made this mistake in 1936 when, believing the Depression largely over, he sought to pare back public spending and to balance the federal budget. It torpedoed a fragile recovery and pushed the economy back under water in 1937.

Japanese leaders made a similar mistake in the 1990s when they prematurely - and temporarily - withdrew government stimulus spending, helping to prolong Japan's recession to one that lasted a full decade.

At the White House, presidential spokesman Robert Gibbs dismissed suggestions by some, including Liz Ann Sonders, chief investment strategist for brokerage Charles Schwab, that the recession may have ended.

"I can report nobody has intoned that message" at daily White House economic briefings, Gibbs said. "There's much work to be done."

Veteran budget analyst Stanley Collender said increases in public spending are an important fiscal tool and that "a bigger deficit is justified in the current economic environment."
Furthermore, Collender added, if Obama doesn't push his agenda for more health care, energy and education spending now, when will he?

"He's got a 60-percent-plus approval rating. And Democrats are willing to work with him. He should go for it now. He's never going to get a better chance," Collender said.

Monday, May 18, 2009

Obama's Risky Debt

By Robert J. Samuelson
Washington Post
Monday, May 18, 2009

Just how much government debt does a president have to endorse before he's labeled "irresponsible"? Well, apparently much more than the massive amounts envisioned by President Obama. The final version of his 2010 budget, released last week, is a case study in political expediency and economic gambling.

Let's see. From 2010 to 2019, Obama projects annual deficits totaling $7.1 trillion; that's atop the $1.8 trillion deficit for 2009. By 2019, the ratio of publicly held federal debt to gross domestic product (GDP, or the economy) would reach 70 percent, up from 41 percent in 2008. That would be the highest since 1950 (80 percent). The Congressional Budget Office, using less optimistic economic forecasts, raises these estimates. The 2010-19 deficits would total $9.3 trillion; the debt-to-GDP ratio in 2019 would be 82 percent.

But wait: Even these totals may be understated. By various estimates, Obama's health plan might cost $1.2 trillion over a decade; Obama has budgeted only $635 billion. Next, the huge deficits occur despite a pronounced squeeze of defense spending. From 2008 to 2019, total federal spending would rise 75 percent, but defense spending would increase only 17 percent. Unless foreign threats recede, military spending and deficits might both grow.

Except from crabby Republicans, these astonishing numbers have received little attention -- a tribute to Obama's Zen-like capacity to discourage serious criticism. Everyone's fixated on the present economic crisis, which explains and justifies big deficits (lost revenue, anti-recession spending) for a few years. Hardly anyone notes that huge deficits continue indefinitely.

One reason Obama is so popular is that he has promised almost everyone lower taxes and higher spending. Beyond the undeserving who make more than $250,000, 95 percent of "working families" receive a tax cut. Obama would double federal spending for basic research in "key agencies." He wants to build high-speed-rail networks that would require continuous subsidy. Obama can do all this and more by borrowing.

Consider the extra debt as a proxy for political evasion. The president doesn't want to confront Americans with choices between lower spending and higher taxes -- or, given the existing deficits, perhaps both less spending and more taxes. Except for talk, Obama hasn't done anything to reduce the expense of retiring baby boomers. He claims to be containing overall health costs, but he's actually proposing more government spending (see above).

Closing future deficits with either tax increases or spending cuts would require gigantic changes. Discounting the recession's effect on the deficit, Marc Goldwein of the Committee for a Responsible Federal Budget puts the underlying "structural deficit" -- the basic gap between the government's spending commitments and its tax base -- at 3 to 4 percent of GDP. In today's dollars, that's roughly $400 billion to $600 billion.

It's true that since 1961 the federal budget has run deficits in all but five years. But the resulting government debt has consistently remained below 50 percent of GDP; that's the equivalent of a household with $100,000 of income having a $50,000 debt. (Note: Deficits are the annual gap between government's spending and its tax revenue. The debt is the total borrowing caused by past deficits.) Adverse economic effects, if any, were modest. But Obama's massive, future deficits would break this pattern and become more threatening.

At best, the rising cost of the debt would intensify pressures to increase taxes, cut spending -- or create bigger, unsustainable deficits. By the CBO's estimates, interest on the debt as a share of federal spending will double between 2008 and 2019, to 16 percent. Huge budget deficits could also weaken economic growth by "crowding out" private investment.

At worst, the burgeoning debt could trigger a future financial crisis. The danger is that "we won't be able to sell [Treasury debt] at reasonable interest rates," says economist Rudy Penner, head of the CBO from 1983 to 1987. In today's anxious climate, this hasn't happened. American and foreign investors have favored "safe" U.S. Treasurys. But a glut of bonds, fears of inflation -- or something else -- might one day shatter confidence. Bond prices might fall sharply; interest rates would rise. The consequences could be worldwide because foreigners own half of U.S. Treasury debt.

The Obama budgets flirt with deferred distress, though we can't know what form it might take or when it might occur. Present gain comes with the risk of future pain. As the present economic crisis shows, imprudent policies ultimately backfire, even if the reversal's timing and nature are unpredictable.

The wonder is that these issues have been so ignored. Imagine hypothetically that a President McCain had submitted a budget plan identical to Obama's. There would almost certainly have been a loud outcry: "McCain's Mortgaging Our Future." Obama should be held to no less exacting a standard.

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