Soaring deficits cast a shadow over the dollar

Irwin Stelzer: American Account

$2,000,000,000,000. That’s the amount by which the Obama administration raised its 10-year estimate of the nation’s budget deficit from the $7 trillion it guessed only a few months ago, a 30% error. It seems that expenses are higher than estimated — up 24% this year, the largest increase since the height of the Korean war — and revenues are lower.

There’s worse. The new estimate assumes that Medicare and Medicaid (government healthcare) spending will be cut by $622 billion, even though Congress has made it known that it is reluctant to make any such cut. Then there is the $600 billion in revenue included for the sale of emission permits, despite the fact that The House of Representatives has given away so many permits gratis that the programme will produce at most $450 billion. Those two items alone come to almost another $1 trillion in red ink. Throw in another $1 trillion for Obamacare, recognise the irrational exuberance of Obama’s economic and revenue projections, and it is no surprise that senior economist Bill Gale, at the liberal Brookings Institution, says that the deficit will exceed $10 trillion over the next decade, a figure he finds “deeply alarming”. So do voters, who now rate the deficit as the nation’s No 1 problem.

This year, the deficit will come to 11.2% of GDP, and by 2019 the debt will be equal to 76% of the value of the nation’s output of goods and services, almost double the 41% when Obama took control of the nation’s finances. Not a problem, White House economists tell me. Not sustainable, says Warren Buffett, among others.

Which brings us to Martha’s Vineyard and Beijing. A tie-less president took time off his vacation on Martha’s Vineyard to praise and reappoint an also tie-less Ben Bernanke to another four-year term as chairman of the Federal Reserve Board. The lack of neckwear could not conceal a certain tension. The president was trying to divert attention from the grim news about his burgeoning budget deficits, and the chairman was trying to reassure the markets that his reputation as “Helicopter Ben”, a man who would fight recessions by dropping cash from the skies, might be merited when the economy is in freefall, but did not preclude him from reining in all that liquidity when the right time comes.

Given that his new term runs until the end of January 2014, Bernanke can with impunity tighten, if he thinks that is necessary, just as Obama launches his 2011 campaign for a second term. Recall that it was just such a tightening and consequent slowing of the economy by Alan Greenspan that George Bush the elder still feels handed the 1992 election to Bill Clinton. Gratitude is not a central banker’s dominant emotion when it interferes with sensible policy.

So the marriage of convenience between Democrat Obama and Republican Bernanke might not end on a pleasant note. Especially if the chairman decides sooner rather than later that the era of quantitative easing — jargon for printing money — must come to an end lest the dollar begin to take on the characteristics of the now-deceased (but remembered with fondness in Italy) lira.

New data support Bernanke’s view that the worst of the recession is probably over. Last week the Department of Commerce announced that sales of new homes rose 9.6% in July after an increase of 9.1% the previous month. Sales are still 13.4% below last year, but are up 32% from the January record low.

The news from the market for all homes, existing as well as new, was even cheerier, especially since it is based on a larger number of sales and is less subject to revision. The much-watched Case-Shiller index of house prices in 20 metropolitan areas recorded an increase of 2.9% during the second quarter. Prices remain 14.9% below the second quarter of last year, but have risen in 18 of the 20 areas covered by the index, prompting Karl Case (of Case-Shiller) to announce: “When I saw those numbers, I danced a jig. It appears that the housing market is stabilising quicker than people thought.”

The sales strength was due in part to low interest rates, in part to a rise in consumer confidence, and in part to an $8,000 tax credit for first-time home- buyers, due to expire on November 30.

The pace of manufacturing is also picking up. The index of leading economic indicators, the Philadelphia Fed survey, and the Empire manufacturing index (New York State) all reported gains, leading Goldman Sachs to conclude “that manufacturing is in the early stages of a rebound to correct undue liquidation of inventories”.

On to Beijing, on which Bernanke is keeping a wary eye. The Chinese, who hold $776 billion in American IOUs (after selling $25 billion in June), see the combination of these signs of an emerging recovery, along with huge deficits as far ahead as the eye can see, as a sign that the dollar is certain to deteri- orate in value. They want Bernanke to follow the lead of his doctoral supervisor at Princeton, Stanley Fischer, now governor of the Bank of Israel, and start to raise rates to head off inflation. Israel is, of course, a tiny player in the world economy, but, as James Lord, an economist with London-based Capital Economics puts it, the response of its central bank to the financial crisis “has been sophisticated . . . [and] Bernanke’s preferred method for reversing any inflationary impact … is essentially what the Bank of Israel has done ”Bernanke’s preferred method for reversing any inflationary impact . . . is essentially what the Bank of Israel has done”.

Bernanke hopes Beijing has enough faith that he has a viable exit strategy to continue buying huge amounts of US Treasury securities. The Fed chairman, not confident that the recovery is yet robust, wants to hold off raising interest rates.

Retail sales remain weak, commercial-property loans look increasingly toxic, about one-third of American banks have tightened credit standards in recent months, failures of regional banks are on the rise, the list of problem banks is at a 15-year high, and boardrooms are not full of members eager to approve big investment projects.

Bernanke wants to go down in history as having defeated a recession without triggering inflation. He is halfway there. (Irwin Stelzer, The Sunday Times)


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