Brave New World of Governmental Finance

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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

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.

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.

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.

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.

12, 2009

Eric J. Fry has been
a specialist in international equities since the early 1980s. He
was a professional portfolio manager for more than 10 years, specializing
in international investment strategies and short-selling. Mr. Fry
launched the sometimes abrasive, mostly entertaining and always
insightful Rude
. His views and investment insights have appeared in
numerous publications including Time, Barron's, Wall Street
Journal, International Herald Tribune, Business Week, USA Today,
Los Angeles Times, San Francisco Chronicle and Money.
He appears regularly on business news stations like CNBC and Fox.

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