Brave New World of Governmental Finance

Eighty-two steps back…one step forward.

Last fall, without so much as a grunt from an elected official, the former Treasury Secretary of the United States doled out $170 billion dollars to the incompetents at AIG. Yesterday, the current President of the United States announced triumphantly that his new budget would “save” $17 billion, thanks to the elimination of 121 federal programs.

In other words, ten steps back…one step forward.

But the story gets worse. Obama’s new budget will also include numerous “non-saving” items that, taken together, will produce a projected budget deficit in 2010 of $1.38 trillion – a figure that is 82 times great than the $17 billion savings that Obama triumphantly proclaimed.

And let’s not forget that real-world estimates of the federal deficit would add several hundred billion dollars to the government’s optimistic $1.38 trillion forecast. Nor should we forget that during the last few months the government has added trillions – literally, trillions – of dollars of direct and implied guarantees to the liability side of its balance sheet.

In this context, $17 billion of savings doesn’t look like savings at all; it simply looks like a tiny dollop of credit that the government has not yet inhaled.

Here’s a news flash folks: Money you do NOT borrow does not constitute “savings.” But this elementary fact does not prevent politicians, professional investors or journalists from utilizing the vernacular of thrift to describe one of the most reckless credit binges in the history of mankind.

Raw arithmetic does not seem to play a role in the national budgetary debate. These days, as long as you’ve got a good speech writer and a compliant populace, you can convert any act of fiscal idiocy into an icon of fiscal prudence.

But let the record state that untapped credit lines are not the same thing as savings. And let the record further state that nations do not amass wealth by amassing debt. Yet, amassing debt is exactly the strategy that Americans have pursued for many years…and it is also exactly the strategy that the current Administration is pursing in the pursuit of resurgent prosperity.

The strategy won’t work…But it might be good for gold bugs.

“What marks our Great Recession for greatness is neither the loss of jobs nor the shrinkage in GDP,” declares James Grant, editor of Grant’s Interest Rate Observer, “but the immensity of the federal response to those afflictions. The scale of the government’s intervention is much more than unprecedented. Before 2008, it was unimaginable. We have reached the ‘kitchen sink’ phase of US counter-cyclical policy.”

“To try to exorcise the Great Depression, President Herbert Hoover deployed fiscal and monetary stimulus equivalent to 8.3% of gross domestic product,” says Grant. “To banish the demons of 2008-9, successive administrations have spent, or encouraged to printed, the equivalent to 28.9% of GDP. A macroeconomist from Mars, judging by these data alone, would never guess how much more severe was that depression than this recession. The decline in real GDP from August 1929 to March 1933 amounted to 27%; that from December 2007 to date, just 1.8%… so for a slump 1/15 as severe as the Depression, our 21st-century economy doctors administered a course of treatment more than three times as costly.”

What does this all mean? Well, it probably means a couple of things, at least. The first thing it means is that the government will debase the currency for the sake of reviving the economy. A weakening dollar seems like one of the very best trades of the next three to five years. The second thing that the government’s outsized response means is that America’s national finances will be a disaster for years to come. No one can borrow $1 trillion without somehow paying a price… not even the richest country on the planet.

The stock market rally of the last two months implies that the economy is recovering. But that’s a lie. The economy is not recovering, no matter how many times CNBC’s Larry Kudlow argues to the contrary. The economy is contracting…in almost every industry and in almost every way. Recovery takes time.

“The deceptions of the Bubble Epoque, 2001-2007, were enormous,” writes Bill Bonner, here at Daily Reckoning. “The correction has been enormous too. And here are the same economists who mismanaged the economy, offering advice to governments who mismanaged their regulatory roles, about how to keep mismanaged companies alive, so that bondholders who mismanaged their investments might not go broke. That this will result in more misery is a foregone conclusion…The measure of that misery, if our iron law holds, is how adamantly governments fight to keep their mismanagement going.

“Just looking at the numbers, the toll will be monstrous,” Bonner continues. “All over the world, interest rates have been cut and budgets padded. France’s deficit is running at 8% of GDP. England is running a deficit of more than 12% of GDP. And the U.S. is mobilizing as if it had been attacked by Martians. On the credit side, the feds have cut rates more than ever before, for a monetary boost equivalent to 18% of GDP, according to Grant. As to spending, $13 trillion has been pledged…an amount equivalent to a full year’s annual output of the United States of America. This response is 3 times more (adjusted to today’s dollars) than the U.S. spent to fight WWII. It is 12 times more (relative to GDP) than the total committed to fight the Great Depression.”

Maybe this massive bet will payoff. But in times past, whenever governments have “gone all in,” currency debasement was sure to follow…and a gold rally was never far behind.