On the Speech, the Economy & Runaway Debt

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
February 1, 2011

IN THIS ISSUE:

1. Obama’s SOTU Criticized by Washington Post

2. Why the $800+ Billion Stimulus Didn’t Work

3. CBO Says Deficit Will Hit $1.5 Trillion in 2011

4. Some New Hawkish Faces at the Fed

Introduction

This week we will touch several bases. While President Obama’s State of the Union (SOTU) address is pretty much old news by now, there are a couple things I would like to touch on that you might have missed. Most notably that he was roundly criticized by the Washington Post, one of the more left-wing papers in the country. Now that’s certainly very unusual!

Despite the mood of the country to cut government spending, Obama outlined a long list of projects he wants to spend more money on. It’s as if he learned nothing from the mid-term elections and the latest Rasmussen polls of likely voters who want spending cut.

Next, I recently ran across a very good article on why the $860 billion stimulus hasn’t worked as expected (or at all). I think you’ll find it very interesting. From there, we move on to the latest deficit forecasts from the Congressional Budget Office. Think $1.5 trillion!

Finally, we’ll take a look at the latest report from the Fed regarding monetary policy going forward. While last week’s Fed report indicated “more of the same” for now, there are some new faces on the FOMC that may be ready to shake things up. I’ll tell you why as we go along.

There are several charts included below, so the letter will look longer than usual as a result.

Obama’s SOTU Criticized by Washington Post

President Obama’s State of the Union (SOTU) address last Tuesday night is mostly old news by now, so I won’t weigh in extensively. But there are a couple of things I will point out that may not have appeared on your radar screen. As noted above, what struck me as stunning was the fact that the left-leaning Washington Post overtly criticized President Obama’s SOTU speech in its editorial pages the next day. Here are three excerpts from the article:

“President Obama entered office promising to be a different kind of politician - one who would speak honestly with the American people about the hard choices they face and would help make those hard calls. Tuesday night's State of the Union Address would have been the moment to make good on that promise. He disappointed.

The reality, as Mr. Obama understands, is that the country is headed for fiscal catastrophe unless it does some politically unpopular things: unwind the Bush tax cuts, including for the middle class; reduce projected Social Security benefits for future retirees, exempting the poor and disabled; rein in the cost of health care; limit popular income tax deductions. Mr. Obama knows this, but last night he did little to prepare Americans for any of it.

From the man who promised to change Washington, it seemed all too drearily familiar.” (See link below for the full article.)

Wow! The Washington Post is one of the most liberal newspapers in the country and normally lavishes President Obama with praise. For the Post’s editorial board to come out and blast him in this way is truly amazing. Of course, they weren’t the only ones – dozens of negative articles on his SOTU speech appeared the next day, with several from other liberal pundits.

The only other point I would make about Obama’s SOTU speech is this: While the president did talk briefly about our national debt dilemma, he talked much more about the need to spend more money. Obama spoke ambitiously of putting more money into roads, bridges, research, education, efficient cars, high-speed rail and other initiatives in his State of the Union address.

He pointed to the transportation and construction projects of the last two years and proposed "we redouble these efforts." He coupled this with a call to "freeze annual domestic spending for the next five years." Note that a freeze doesn’t cut anything. Obama offered far more examples of where he would spend than where he would cut, and some of the areas he identified for savings are not certain to yield much, if anything.

The bottom line is simply that President Obama is a big government, tax-and-spend liberal at heart. Most of us knew that before the unknowing American people elected him. No wonder that his words on the need to address the national debt crisis rang hollow. Following the SOTU address, Senator Jim DeMint (R-SC) noted:

"Unfortunately, we can’t trust what he says anymore…”

All I can say is, it’s about time you figured that out Senator! We knew it all along.

As a final point on the President’s SOTU address, a Rasmussen poll conducted after the speech found that 50% of likely voters now oppose the federal government spending more money in areas like education, transportation, technological innovation, etc., up from 45% before the speech. Only 41% favor the idea.

In the same Rasmussen poll, 49% of voters now say cutting federal spending is better for the economy than increasing federal spending in these targeted areas, up from 47% before the speech. Only 34% disagree and say increasing spending is better. It is amazing that almost 50% of likely voters favor cutting federal spending! But Obama either doesn’t understand this, or he doesn’t care.

Why the $800+ Billion Stimulus Didn’t Work

When Congress approved Obama’s initial $787 billion stimulus plan in February 2009 (which later ballooned to around $860 billion), many of us questioned whether it would work, and raised concerns about how it would explode the federal deficit. Others, however, argued that without the huge stimulus, the economy would have gone from recession into depression.

But now almost two years later, there is fairly widespread agreement that the gigantic stimulus effort didn’t work as expected. Two well-known economists from Stanford University recently published a very interesting study which examines why the stimulus didn’t work. What follows is a summary of that study published in Investor’s Business Daily on January 26:

The Economic Stimulus That Wasn't

By Investor's Business Daily

Economy:Did the hundreds of billions spent to stimulate the economy do the job? And where did all that money go, anyway? A new report crunches the data and finds answers that are devastating for stimulus backers.

Done by Stanford University economists John Cogan and John Taylor and published in Commentary Magazine, the report is blunt in its assessment of President Obama's Keynesian stimulus package: "There was little if any net stimulus."

Worse, say the authors, the White House with its bevy of hip Keynesian-leaning economists should have known it wouldn't work. "The irony," they write, "is that basic economic theory and practical experience predicted this would happen." In other words, the Obama camp should have known better.

But why the stimulus didn't work is a little more complex. The authors break down the three kinds of Keynesian stimulus packages.

In one, government gives money to consumers and hopes they spend it. In another, the federal government directly buys goods and services, ranging from computers to building infrastructure. In the third, government hands money to state and local governments to spend.

The $862 billion stimulus package passed by Congress and signed into law by the president tried to do all three things. Unfortunately, none of them worked - a huge repudiation of the ideas behind Keynesianism.

In the case of money handed over to consumers, "It went to pay down some debt or was simply saved rather than spent on consumption." What about federal infrastructure spending on "shovel-ready" projects? Didn't that work? Hardly. In fact, what's stunning is to discover how little was actually spent on this, the supposed centerpiece of stimulus.

At the federal level, the stimulus generated just $20 billion in added government purchases, about 3% of the total spent. And of that amount, only $4 billion was spent on infrastructure. Four billion - that's it.

Then there were the grants to state and local governments, which were expected to get local economies revving again. Didn't happen, according to Cogan and Taylor.

From the time the stimulus was first enacted in March 2009 to the end of the third quarter of last year, $173 billion was handed out to state and local governments under the plan, the authors say. The impact of all that money? "Negligible."

The reason for this is simple: State and local governments didn't use the money to "stimulate" anything. Instead, they used it to reduce borrowing. In short, we were issuing massive amounts of federal, taxpayer-funded debt to help poorly run states reduce their own borrowing.

This analysis, of course, only addresses how the money was spent - and how little impact it actually had on the macro economy. What it doesn't discuss is that the stimulus failed in another important way: It didn't increase jobs.

The U.S. had 109.51 million private-sector jobs in March 2009. As of December 2010, there were 108.45 million jobs - a decline of nearly 1.1 million. So when the White House claims to have "saved or created" as many as 3.5 million jobs with its stimulus efforts, it's an outright falsehood.

But surely, you say, the $700 billion spent on TARP to bail out U.S. companies and buy up bad loans helped prevent something worse. Well, maybe not.

In remarks prepared for delivery Wednesday to Congress, TARP's special inspector general, Neil Barofsky, is expected to say that the program's lasting legacy is a sorry one:

"In short, the continued existence of institutions that are 'too big to fail' - an undeniable byproduct of former Secretary Paulson and Secretary Geithner's use of TARP to assure the markets that during a time of crisis that they would not let such institutions fail - is a recipe for disaster."

Hardly a vote of confidence for more meddling in the economy.

The world has known at least since the 1970s that Keynesian "stimulus" is a dead end. Yet like a movie vampire, it keeps rising from the grave of bad ideas. If we get nothing else for the money, can't we at least use these data to put an end to such silly superstitions?

Perhaps these facts explain why President Obama didn’t hail the effects of the $860 billion stimulus package in his SOTU speech last Tuesday. This massive stimulus spending segues perfectly into our next topic for this week.

CBO Says Deficit Will Hit $1.5 Trillion in 2011

Before getting into this topic, I should note that the Commerce Department reported last week that 4Q GDP came in at +3.2% (annual rate) following 2.6% in the 3Q. Actually, the pre-report consensus was for a gain of 3.7%, so the report was a bit of a disappointment. Now let’s move on to the latest figures from the Congressional Budget Office (CBO).

With the extension of the Bush-era tax cuts, the reduction in payroll taxes and increases in government spending enacted late last year, the CBO updated its estimate of the federal budget deficit for fiscal 2011 and conveniently released that data last week on the day after President Obama’s SOTU speech.

For fiscal 2011, the Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion, or 9.8% of GDP. The CBO offers the following analysis of why our deficits have skyrocketed since 2008:

For the federal government, the sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity—combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession—have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and 8.9 percent of the nation's output, respectively.

… Just two years ago, debt held by the public was less than $6 trillion, or about 40 percent of GDP; at the end of fiscal year 2010, such debt was roughly $9 trillion, or 62 percent of GDP, and by the end of 2021, it is projected to climb to $18 trillion, or 77 percent of GDP.

Note that the references above to the national debt of $6 trillion two years ago and $9 trillion at the end of last year represent only the national debt “held by the public” and does not include debt held by “intragovernmental agencies” (ie – Social Security, OASI Trust Fund, etc., etc.). The total national debt now stands at almost $14.1 trillion. That represents 96.5% of total GDP which was $14.5 trillion in fiscal 2010. The CBO goes on:

With such a large increase in debt, plus an expected increase in interest rates as the economic recovery strengthens, interest payments on the debt are poised to skyrocket over the next decade. CBO projects that the government’s annual spending on net interest will more than double between 2011 and 2021 as a share of GDP, increasing from 1.5 percent to 3.3 percent. [Emphasis added.]

Before we leave the subject of our out-of-control national debt, here is a very interesting graphic from the International Monetary Fund which recently appeared in the Financial Times of London:

Structural Deficit

In these periodic reports, the CBO also provides its latest forecasts for the US economy:

Although recent actions by U.S. policymakers should help support further gains in real (inflation-adjusted) GDP in 2011, production and employment are likely to stay well below the economy's potential for a number of years. CBO expects that economic growth will remain moderate this year and next. As measured by the change from the fourth quarter of the previous year, real GDP is projected to increase by 3.1 percent this year and by 2.8 percent next year [2012].

One reason the CBO’s forecast for GDP growth next year is lower than the consensus estimates I wrote about last week (from the WSJ and BCEI surveys) is the fact that the government stimulus spending ends in 2011. This raises the question of whether President Obama and/or Fed Chairman Bernanke will call for more stimulus later this year or next year.

With polls like Rasmussen and others showing that 50% of likely voters want less government spending, I doubt that President Obama will call for more federal stimulus, and I certainly don’t think it would pass in the House. And as I will discuss below, there are new reasons to believe that the Fed won’t be rolling out QE3 when QE2 ends in late June.

Some New Hawkish Faces at the Fed

As most readers know, the Federal Reserve’s monetary policymaking arm is the Fed Open Market Committee (FOMC). You may also know that the FOMC is made up of the Chairman, currently Ben Bernanke, Vice-Chairman William Dudley, five Fed Governors and four Federal Reserve Bank presidents (out of 12) on a one-year rotating basis. The FOMC meets roughly every six weeks, and after each meeting an official “policy statement” is issued and can be found on the FOMC website.

Modern-day meeting of the Federal Open Market Committee at the Eccles Building, Washington, D.C. In January, four new Reserve Bank presidents rotated into the FOMC as voting members. Two of those bank presidents – Richard Fisher of the Dallas Fed and Charles Plosser of the Philadelphia Fed – have both let it be known for some time that they disagree with the Fed’s easy money policies and QE2 in particular. Both have voiced concern that quantitative easing will lead to higher inflation in the future.

The first FOMC meeting of the year took place last week with the new members in place. The policy statement from last week’s meeting is almost a carbon copy of the statement released in December. Specifically, the Fed Funds rate will remain near zero, and monthly QE2 purchases of Treasury bonds (apprx. $75 billion a month) will continue until mid-year.

At this first meeting of the year, the vote was unanimous in favor of the policy actions in the preceding paragraph. Both Fisher and Plosser voted in favor, most likely out of respect for Bernanke and with it being their first meeting as voting members. However, most Fed watchers believe that Fisher and Plosser would vote against more QE beyond June when QE2 is scheduled to end, and might solicit other FOMC members to join them. As a result, most observers now believe that Fed Chairman Bernanke won’t go there.

The trillion-dollar question is, how and when will the Fed ever unload the apprx. $1.5 trillion it holds in mortgage backed securities and Treasuries it purchased during the credit crisis. The Fed’s so-called balance sheet held fairly steady at around $900 billion in assets prior to the credit crisis. Yet in the summer of 2008, the Fed began aggressively buying toxic assets to try to unfreeze the credit markets. In just a few months, the Fed’s balance sheet exploded to above $2.2 trillion. As a result of QE2, it has risen to almost $2.5 trillion as you can see in the chart below.

Total Assets of the Federal Reserve

Most of the Fed watchers I read believe that the Fed is content to hold onto these assets until such time as the economy is healthy again. Most do not believe the Fed will begin to unload assets this year as it would likely raise interest rates and possibly slow down the economy too much. If the CBO estimate for growth of only 2.8% in 2012 proves accurate, the Fed may be sitting on these enormous assets for several years longer.

I had a couple of other topics on my mind for this week, but space doesn’t allow and it’s time to hit the send button.

I’m looking forward to the Super Bowl this Sunday. We’re having some friends over to watch the game as usual. The matchups are very good, so I expect it will be an exciting game this year. Enjoy!

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Washington Post – Obama Disappointed
http://www.washingtonpost.com/wp-dyn/content/article/2011/01/25/AR2011012504573.html

A good plan to restore growth in the economy & lower unemployment (Read this)
http://online.wsj.com/article/SB10001424052748704268104576107951413818460.html?mod=WSJ_Opinion_LEADTop

UK Telegraph - Obama in Denial Over US Debt
http://blogs.telegraph.co.uk/news/nilegardiner/100073619/the-obama-presidency-remains-in-a-dangerous-state-of-denial/