The National Deficit: Inside the Belly of the Beast-Minyanville

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The National Deficit: Inside the Belly of the Beast

John Mauldin Jun 02, 2009 7:40 am

The National Deficit: Inside the Belly of the Beast


		Three possible paths down which the US can go from here.

In fantasy novels, the intrepid heroes come across a sign saying "This Way Be Dragons." Of course they venture on, facing calamity and death. But such is the nature of fantasy novels. We live in a very real world, and if we don't turn back, there will be some very nasty dragons in our future. This week we look at 3 possible paths we can lead the world down. We then review a number of charts and data on the housing market.

This Way Be Dragons

More and more, we read about the growing concern over $1-trillion deficits. Stanford professor John Taylor (creator of the famous Taylor Rule) jumped into the debate with a rather alarming op-ed in the Financial Times this week, echoing much of what I wrote last week, but with some real insights into what trillion-dollar deficits mean.

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"I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor's considers. The deficit in 2019 is expected by the CBO [congressional Budget Office] to be $1,200 billion (€859bn, £754bn). Income tax revenues are expected to be about $2,000 billion that year, so a permanent 60% across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

"Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100% increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82%. A 100% increase in the price level means about 10% inflation for 10 years. But it would not be that smooth - probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every 3 or 4 years, and a successively higher inflation rate after each recession."

You can read the rest here.

While Obama gives lip service to cutting the deficit in half, his actual budget increases it over the next 10 years. As I’ve been writing for some time, this is a very dangerous path and one the bond market seems to be concerned about. Interest rates are rising, even on mortgages that the Federal Reserve is buying in massive quantities in its effort to hold down rates and stimulate the housing market.

Taylor concludes:

"The good news is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one."

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