U.S. Federal Budget Deficit to Exceed $1 trillion in 2009

By: Hans_Wagner

Investors trying to beat the market and learning to invest need to consider the impact of the large budget deficits now being considered by the U.S. government. The incoming administration and the new congress intend to spend a lot of taxpayer money to stimulate the economy and fund their programs. This will drive up the already high U.S. deficit now over $10 trillion, or more than $33,000 for each man, women and child in the U.S. So will the contemplated deficit spending do the job or just increase the debt of everyone?

The New New Deal

President-elect Obama says we should not worry about the federal budget deficit now. As he said in a recent speech, “We have to do whatever it takes to get this economy moving again – we're going to have to spend money now to stimulate the economy. We should not worry about the deficit next year or even the year after; that short term, the most important thing is that we avoid a deepening recession.”

We know that a stimulus package will be passed early next year. At this point, we do not yet know how much this stimulus package will cost. Some have mentioned $700 billion. 2008 Nobel-prize winning economist Paul Krugman says that this level is way too small. Some analysts believe more than $1 trillion is needed.

Krugman is a major proponent of the new New Deal. However, he wants it done right; because he believes Franklin D. Roosevelt was too timid. He was too cautious. Krugman follows John Maynard Keynes complaint, that Roosevelt's budget deficits were too small.

University of Arizona economists Price Fishback wrote recently “Once we take into account the taxation during the 1930's, we can see that the budget deficits of the 1930's and one balanced budget were tiny relative to the size of the problem.”

The problem is that while Roosevelt spent more, he also raised taxes substantially. This offset some of the positive affects of the government spending. These policies did not correct the Depression nor did they correct unemployment. As Roosevelt's treasury secretary said, “After eight years of this administration we have just as much unemployment as when we started.” Contrary to what many believe FDR did not overcome the depression. It took World War II to accomplish that task with its enormous spending on the war effort.

Krugman and other economists suggest that since the New Deal ran moderate deficits and the Depression persisted, then Roosevelt should have run much higher multiyear deficits. They believe Obama must do the same if he expects to overcome the current economic malaise and lead the economy back to prosperity.

Where Real Growth comes from

The problem is that government programs rarely achieve what is promised. We have seen the promise of new sources of energy to remove the U.S. dependence on foreign oil. In 1980, during an earlier oil crisis that included an oil embargo, President Carter created the Synthetic Fuels Corporation, spending $19 billion of taxpayer's money on it. Nothing was achieved and the entity was disbanded in 1985. The basic problem was the government was trying to create a market for a fuel that ended up to high priced, so no one wanted to pay for it.

The free market works best when corporations know the rules and have the confidence that these rules will remain the same for the foreseeable future. Uncertainty causes businesses to hold back investment in new plants and people.

Many believe that the New Deal failed because it interfered with the market's natural ability to weed out the businesses that are less productive. By raising taxes, adding new regulations that tied producers' hands and creating uncertainty as to what the government would do next, business leaders were unwilling to invest and hire workers.

The government does not create wealth and prosperity. When the government gets involved, spending more than it takes in, it tends to stifle economic growth.  When the Treasury borrows money, it competes with other enterprises for the investors' capital. The more the Treasury borrows the less money is available for corporations to use for investment. What if China, who holds a significant portion of the U.S. debt decided to spend the money on their own stimulus package. Then why would be sellers of U.S. debt, rather than purchasers. This would tend to push rates up, to encourage those with cash to invest.

Business growth is the primary vehicle to recover from a recession and drive prosperity. Governments depend on taxpayers to fund their programs. If government takes money out of private enterprises hands, it reduces the amount of taxes that can be collected, since the businesses are not making as much money. When tax collections fall, it pushes up the deficit as well.

Of course, the Federal Reserve can just “print more money.” A larger money supply helps offset the competition for investors' money. In the last four months, the money supply as measure by M2 has grown by 13.8% annualized. This is very rapid growth, as normally the money supply tends to grow at the pace of the economy. When the money supply grows rapidly, it tends to create inflation over time. The excess money eventually drives up the price of goods and services and causes the value of the currency to fall.

The Bottom Line

According to the latest numbers from the government, the deficit for 2009 is expected to be $438 billion. This is before the recent programs such as the TARP, any bailout for the auto companies, another stimulus package and other programs on the new administration's wish list. This deficit number assumes normal growth in the economy with rising tax collections. This is unrealistic as unemployment is rising rapidly and companies are seeing profits fall quickly with sales declining. At a minimum, the deficit will reach $1 trillion and more likely achieve the $2 trillion mark. In one year, we will see the total deficit of the U.S. rise by 10 to 20 percent. That is another $3,300 to $6,600 for each man, women and child in the U.S. The deficit of the U.S. is climbing faster than the income of the people. At some point, this large deficit will haunt our children. Not the legacy we want to leave to them.

If you are interested in learning more about the impact of the economy on investors, I suggest reading:

Economic Growth by David Weil. An easy to read book that presents the key factors to understand global economies. It is expensive and is used as a textbook for college students, but it is worth the money.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2008 Hans Wagner

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