The Daily Reckoning - Do Deficits Matter? (Dan Denning)

verfasst von Firmian, 28.02.2004, 11:23

-->Do Deficits Matter?

The Daily Reckoning

Paris, France

Thursday 26 February 2003


---------------------

*** A surprising chance encounter...

*** Father Greenspan blesses the economy... but condemns
federal deficits! The faithful respond - stocks soar
heavenward...

*** The third sensible remark by a policy wonk this
week... Do deficits really matter? And more...

---------------------

"Excuse me... I couldn't help but overhear your
conversation... do you really believe that the jobs picture
will improve? I mean... really?"

"The lesser of your two evil Parisian editors found himself
in a fortuitous position on a yesterday's flight from Paris
to Boston (en route for Puerto Vallarta)..."

So begins a cryptic e-mail from Addison Wiggin. Apparently,
while making his way to the Supper Club meeting in Mexico,
Addison found himself seated next to an economics professor
from Harvard... who claimed to be a friend of Ben
Bernanke's... and a neighbor of former IMF chief economist
Ken Rogoff... and whose office is just across the hall from
the current chairman of the president's Council of Economic
Advisors, Greg Mankiw.

We'll hear more about Addison's chance encounter when he
hits the ground in the land of tequila and cheap blankets.
And since Bill Bonner is making his way back from the sunny
climate of Nicaragua himself, we go straight to Eric
Fry... on the scene, and on the job... in chilly New York
City...

Eric?

------------

Eric Fry in Manhattan...

- Father Greenspan delivered an inspirational homily
yesterday in the halls of Congress. He pronounced the
economy free of blemish, praising its many virtues, while
turning a blind eye to most of its venial sins... like
sluggish employment growth.

- He did, however, caution against the evils of large
federal deficits."As you are well aware," he intoned,
"after having run surpluses for a brief period around the
turn of the decade, the federal budget has reverted to
deficit... For a time, the fiscal stimulus associated with
the larger deficits was helpful in shoring up a weak
economy," the chairman allowed. But the deficits must come
down.

-"To date, actions that would lower forthcoming deficits
have received only narrow support," he noted,"and many
analysts are becoming increasingly concerned that, without
a restoration of the budget enforcement mechanisms and the
fundamental political will they signal, the inbuilt
political bias in favor of red ink will once again become
entrenched."

- Amen, brother! [More on this subject from Strategic's Dan
Denning, in a guest essay below... ]

- But Greenspan did not dwell on the negatives. He ascended
Capitol Hill to deliver a message of victory and of hope.
"The U.S. economy appears to have made the transition from
a period of sub-par growth to one of more vigorous
expansion," he declared."Real gross domestic product (GDP)
rose briskly in the second half of last year, fueled by a
sizable increase in household spending, a notable
strengthening in business investment, and a sharp rebound
in exports... Overall, the economy has lately made
impressive gains in output and real incomes, although
progress in creating jobs has been limited. The most recent
indicators suggest that the economy is off to a strong
start in 2004, and prospects for sustaining the expansion
in the period ahead are good."

- The Faithful embraced Father Greenspan's assessment of
the economy as gospel truth and responded to his message by
chasing lustily after stocks. The Dow Jones Industrial
Average gained 35 points to 10,601, while the Nasdaq
Composite rose nearly 1% to 2,023.

- Inspired by Greenspan's message, the dollar soared
heavenward as well, gaining 1.5% against the euro to
$1.250. We would not be surprised to see it drift a little
higher... but the ill-fated greenback's divine inspiration
is temporary at best.

- The dollar's impressive rally took a lot of shine off of
the gold market. The tarnished metal tumbled $8.70
yesterday to $396.10 an ounce.

- In a world so free from blemish, so devoid of
macroeconomic iniquity, gold is irrelevant. If there are no
demons, evil spirits or looming financial disasters to ward
off, why lug around a relic like gold... especially when the
relics at the Federal Reserve insist that inflation does
not exist?

- Notwithstanding Chairman Greenspan's inability to observe
any inflationary pressures in the economy, a very visible
bit of inflationary pressure is gurgling up from the ground
right beneath him. Crude oil for April delivery tacked on
$1.10 to close at $35.68 per barrel - the loftiest price in
nearly a year.

- And there seems to be a bit of inflationary pressure in
the semiconductor sector as well. The Semiconductor HOLDRs
Trust (SMH:Amex), which bounced 1.5% yesterday, has doubled
over the last 12 months. But SMH investors may be
interested to know that there is a lot of air under this
thing. The P/E ratio of SMH's top 10 components is a hefty
82.4. Furthermore, as options pro Jay Shartsis observes,
"Corporate insider data from Crosscurrents for these stocks
revealed that over the past six months there have been 239
sellers and three purchases... None of this seems to bother
Wall Street analysts who maintain opinions on the group, as
51.2% of their recommendations are buys and only 6% are
sells (with the rest holds, presumably)."

- Wall Street loves 'em... So consider yourselves
forewarned.

------------

Back in Paris...

*** First Mankiw, then Gramlich, now"Father Greenspan," as
our New York editos calls him... what's going on? Not only
did Sir Alan own that burgeoning federal deficits are a
problem that must be addressed - he even proposed cutting
Social Security and Medicare payments. That's the third
reasonable economic statement made by a policy wonk in the
past week.

Of course, as we noted yesterday, there is no constituency
for a balanced budget in the country. But at the very
least, it looks like there may be some lights on in the
U.S. capitol.

Naaah... what are we thinking... that would be too much to
hope for!

*** Below, Dan Denning resumes the subject of federal
deficits, government debt, and the shadow they cast over
the U.S. economy...

---------------------

The Daily Reckoning PRESENTS: How does government borrowing
affect the long-term viability of an economy? Is it even
'moral' to borrow - if you don't intend to settle your
debts? Strategic Investment's Dan Denning weighs in with
his view on the matter, below...


DO DEFICITS MATTER?
By Dan Denning

Do government deficits - and by extension, government debt
- matter? I would argue that they do. In fact, over time,
they erode the long-term ability of an economy to create
wealth... making the pie smaller for all concerned.

Government deficits are unique in the world of debt. The
government doesn't borrow money to create income-producing
assets or make capital investment. The purpose of
government borrowing is not to create wealth, but rather to
redistribute income. And because the government pays off
its bonds with tax revenues which it commands from citizens
under threat of imprisonment, it's able to borrow at much
lower interest rates than the private sector.

To the extent that non-productive government borrowing
crowds out productive, private investment, the economy is
in trouble. But how do you measure the size of the deficit?
At what size does it begin to matter?

If you measure government deficits as a measure of GDP,
they may not seem historically large. But that is not the
main issue - rather, the key economic question, in terms of
sustainability and capital formation, is how large
government deficits are as a percentage of gross saving.

How much is the government claiming from the pool of
available funds? In other words, to what extent is
government borrowing crowding out private investment and
capital formation?

In the 1970s, the federal deficit was 11% of private
saving. By contrast, last summer, the projected federal
deficit of $304 billion was just under 20% of gross saving
of $1.5 trillion. Today, with this year's projected federal
deficit of $521 billion and gross savings in 2003
(excluding December) of $1.8 trillion, the federal deficit
is nearly 30% of gross savings. That is an outrageous
ratio.

In short, the higher the debt - and the deficits - the more
the government has to go into capital markets. Using its
coercion-protected franchise as the"payee of last resort,"
it attract funds from savers into its Treasury bills and
bonds that otherwise would have gone into corporate stocks
and bonds, thereby creating wealth by financing new job-
creating enterprises. Instead, the savings, once sucked
into the government's vortex, are mostly squandered in
wasteful and ineffective enterprises. (Hey, let's go to
Mars!)

Government borrowing diverts savings away from productive
investment and towards simple wealth redistribution. Over
time, capital formation slows down... and so does business
investment. The long-term ability of the economy to create
capital and wealth is hollowed out.

That's my main economic argument against government
deficits. But my most serious bone of contention is moral.
The more content we are with regular government deficits,
the less responsible we become for ourselves. Borrowing
increases actual indebtedness... but it increases
dependence, too.

People get used to expecting things to be paid for and
provided by the government. Once created and funded, how
many government programs have gone away? Very few. These
programs develop a constituency of bureaucrats whose
paychecks depend on them, and/or taxpayers on the receiving
end of the wealth distribution.

The whole exercise in democracy then becomes a shameless
debasing game of looking out for your piece of the loot at
the expense of your neighbors and friends... and your
children and grandchildren.

The root of this argument is that public debt - debt taken
out in the name of the people and not by an individual or
corporate risk taker - quickly becomes a creature of the
political process and winning elections. In time, this
becomes corrosive to private morality.

A useful example is provided by the heat wave experienced
in Europe this summer. In France, fifteen thousand people
who survived the depression and World War II died in their
homes or unattended in hospital beds from the heat. Their
doctors, neighbors, and children were at the beach, on
vacation, confident that the tax dollars they spent were
taking care of their loved ones.

When Chirac gave his speech to the nation addressing the
human catastrophe, he said that no one person was to blame,
but that all of France was to blame. That's pretty
convenient. All of France means not me and not you but all
of us. So let's just do better next time.

Maybe in their private moments the children and neighbors
of these people do blame themselves for subcontracting
their responsibility to take care of their elders to the
government. And then again, maybe they don't. Maybe the
cumulative effect of letting the government become the
moral middleman is that you don't care about anyone but
yourself anymore. You care about your job, your leisure
time, your life. You work less, have fewer children, and
stop believing in God.

It may be a stretch... but I think it all starts the moment
we accept that spending more than we earn - as a nation,
through our government - is morally tolerable. If it's not
good for a private household to do it, not good
economically and not good morally, why would it be better
for the government to do it?

Lots of people will claim that only the federal government
can and should spend money on things like wars and self
defense. Perhaps. But in addition to being controversial,
it's a bit of a red herring. Right now, for instance, are
we really in a war in which the bulk of our national
resources ought to be dedicated to the military to the same
degree as they were in WWII or the Cold War? And even
so... it's the non-military, non-discretionary spending
that's busting the budget anyway.

Seventy percent of government spending is locked up in non-
discretionary promises to pay for things the government
does now, but which used to be done by families, churches,
or the private sector. We have cast these promises in
political granite and have closed the discussion of whether
we ought to or can afford to keep making them.

I would suggest that we not treat our economics as mere
mathematics. Economics used to be called moral philosophy.
The study of the choices people made with their money
couldn't be separated from whether the choices themselves
were"good."

The market judges"good" by whether the good or service you
provide makes things better for people. If it does, you get
rewarded for your risk. If it doesn't, generally, you fail.

Debt isn't immoral per se. But taking on debt you have no
intention of repaying is.

And doing so in the name of the"State" or the"people" may
give you the political cover you need to explain away your
recklessness. You disguise it as concern for the"public
good" or for"society." But morally speaking, when you
sanction it, you're contributing to the impoverishment of
your economy... and the debasement of your own morality.


Regards,

Dan Denning
For the Daily Reckoning

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gesamter Thread:

• The Daily Reckoning - Do Deficits Matter? (Dan Denning) - Firmian, 28.02.2004, 11:23
  • Dt. Fassung - Firmian, 28.02.2004, 11:31