Page 1 of 2 Deficit flights of fancy
By Julian Delasantellis
The Old Testament's Book of Exodus has God, speaking through the burning bush,
promising the young Moses a "land of milk and honey" once he leads his people
out of Egypt into the land of Israel, but, after spending 40 years of exile in
the Sinai. Moses would not live long enough to actually enter his promised
land. He only saw it from afar, from across the tops of the last barrier
mountains that at once guarded and denied his goal.
We're now entering the fourth year since US residential real-estate prices
topped and buckled, taking the entire world financial system with it. Finally,
the clouds are clearing, and, over the tops of the mountains, we can see the
world that will follow upon all this contemporaneous suffering.
A land of milk and honey? Hardly. More like spoilt milk and rancid honey, I'd
say.
The calendar says it's the year of the tiger, but, in the financial
markets, it's the year of the PIIGS - Portugal (2009 estimated current account
deficit US$16.6 billion), Ireland ($5.3 billion), Italy ($55 billion), Greece
($41 billion), and Spain ($69 billion). During the loose morality and even
looser money of the boom, these were the countries that the serpents of Wall
Street were continually tempting with offers of more and more borrowing of the
sulfurous product of Wall Street's leverage factories; now, panic reigns, as
these countries start to be asked the question they thought they would never
face - when, and even how, are all these loans ever going to be paid off.
There is a tried and true method by which all these intra-European finance
tiffs are usually settled - by sticking Hans with the check. Germany, far and
away the richest and most profitable of the 16 component states of the
eurozone, traditionally writes the checks for eurozone bailouts, partly
because, as the zone's richest member, it has the most to lose from a
continent-wide economic collapse; partly because, much like riding a bicycle is
a skill one never forgets, so, the knack of slathering the guilt on Germany for
World War II is similarly never forgotten.
But this time, the Germans are huffing and puffing, seemingly denying their
role as the guys who are going to pay for all the party's broken fixtures and
furniture. Both the German left and right are up in arms over the prospect of
more German taxpayer bailouts of the eurozone periphery, so Chancellor Angela
Merkel, even with just under four years until she is scheduled to face the
voters again, is hanging tough, playing a game of chicken that, unless some
player turns away quickly, could result in the destruction of the euro
currency, the pride, and just about only real, product of European integration.
The Germans are hoping that a hard line taken with Greece will keep the other
European laggards from the door; in the same way that stray cats learn which
doors will produce some tuna for a few meows, the Germans want the whole litter
to either move down the street to another door, perhaps to the World Bank
and/or International Monetary Fund, or control their appetites. In other words,
they want the supplicants to cut their government spending.
But can the Germans really let the PIIGS go? The creation of the euro in 1999
was a particularly prideful moment for the Germany, particularly since the new
currency was so very heavily comprised of the old German deutschmark. This, the
Germans felt, was just a recognition of all the hard work the nation had done
since, and to and expunge the guilt, of World War II.
The debt in question owed by the PIIGS is overwhelmingly denominated in euros.
Whatever is in the German press, foreign exchange traders just do not believe
that Germany is going to let Greece, or any of the PIIGS for that matter,
default, and thus put into question the credibility of their proud euro. Still,
the uncertainty over the issue has engendered a fairly significant euro selloff
against the US$ - the currency is down over 10% since early in the winter. The
PIIGS' national debt is selling off as well, as traders wait to see whether,
and when, the expected German rescue will come - if ever.
But just how bad are the PIIGS' deficits? Surprisingly, not that bad. According
to the Organization of Economic Co-ordination and Development, their current
accounts deficits range from under 12% for Greece to under 3% in Ireland, and
all are in a declining trend. Through a combination of tax hikes and fiscal
austerity, Greece's deficit is on a particularly sharp declining trend,
something that is inhibiting the receptiveness of the Greek population for
further German mandated cuts and more pain.
But what about the country whose name is now frequently dragged through the mud
as the piggiest real pig in the world, the United States, and its supposedly
President Barack Obama-generated huge budget deficits? It probably will
surprise many, but its situation is one which many of the PIIGS could only
dream of. For 2008, the last full year for which statistics are available, the
current account/GDP ratio was a very manageable 4.67%, down a bit from the
previous year due to the mid-year crash in oil prices. For the third quarter of
2009, the ratio was 2.9%, as continued low oil prices and strong demand for US
exports preceded the bump up in US imports the nation is now seeing as the
economy improves.
Then why are so many saying that Greece and the PIIGS are the "for whom the
bell tolls" moment for profligate America? In a recent Investor's Business
Daily editorial, Scott Powell, a managing director of Alpha-Quest LLC, an
alternative investment consulting firm, and a visiting fellow at Stanford
University's Hoover Institution, rang the firebell of the current long winter's
night
" ... given the recent panic over deficit spending in Greece,
which precipitated a doubling in sovereign debt rates in a matter of months, it
is important to understand the dynamics that could precipitate a similar crisis
here at home. US Treasury management has overemphasized the issuance of
short-term over long-term debt. Currently, there are 2.5 times more Treasury
bills issued than 10-year notes and 30-year bonds. In the current
Fed-engineered zero-interest-rate environment, the annual interest cost of
T-bill debt now averages about one-quarter of 1%, while 30-year Treasury bonds
cost about 4.55% annually. The average interest rate of all outstanding
Treasury debt was about 2.55% at the end of 2009, as compared with nearly 5%
during much of 2007 and 6.5% at the end of the previous business cycle 10 years
ago.
The Fed will eventually normalize interest rates, which would take the
government's borrowing cost up at least twofold. A crisis in confidence,
however, could abruptly lead to much higher borrowing costs. The trigger for
the sovereign debt crisis that drove up borrowing costs in Greece by more than
100% in the last three months was primarily tied to its government deficit
exceeding 12% of GDP [gross domestic product]. The expected $1.6 trillion Obama
budget deficit for the upcoming year is approximately 11% of projected US GDP.
Powell is correct when he notes how the US Treasury has shifted its funding
emphasis from long-term bonds and notes to short-term bills. However, with
short-term Treasury Bill rates still under 1% all the way past the one-year
maturity rate on the yield curve, for the moment this seems more like a prudent
stewardship of the country's purse rather than an irresponsible child playing
with matches.
Looking up from my TV one afternoon to see Cambridge/Oxford/Harvard/Stanford
economic history wunderkind Niall Ferguson being interviewed by Fox
News' Glenn Beck, I realized that the only thing I could have seen that might
have surprised me more would have been seeing famed paramour Warren Beatty
taking a crack ho as a date to the Academy Awards. But there he was, once again
making the connection between Greece, economic profligacy, and the misguided
policies of Barack Obama. (For a discussion of Ferguson's globe-straddling
struggle with Paul Krugman of the New York Times over budget deficits and
fiscal stimulus, see
It all comes down to Keynes, Asia Times Online, June 10, 2009.)
Ferguson:
... a very well intentioned leader who for some people
appears to be the solution to their problems can completely wreck the system.
The collapse of the Soviet Union 20 years ago happened with incredible speed.
Nobody was really expecting his [Mikhail Gorbachev's] reforms to completely
destroy not only the Soviet empire but the Soviet Union itself. I worry a
little bit about our own situation today - I think we could collapse much more
quickly than people assume. I hear debates all the time about the crisis in
social security, or the crisis with the national debt, but it all seems to play
out decades away from now, so we cannot worry about it. I think the lesson of
what happened in Europe today and what happened in Russia twenty years ago is
that collapse can sneak up on you, and strike very suddenly indeed. no matter
how good your intentions are ... Ordinary Americans fundamentally don't want
socialism, they don't even want Keynesianism.
The man's sure
got a point there. After accepting the demand management theories of John
Maynard Keynes for over 65 years, suddenly, as winter turned to spring last
year, the entire country suddenly woke up one morning with a vitriolic,
lacerating hatred of the entire theory and its practice.
Whether the media was this phenomenon's cause or effect is debatable; what is
not is the media's complicity. The endless repetition of the actual extent of
the current budget deficit, delivered with familiar American newsreader
gravitas ( "One TRILLION four hundred MILLION", as if the next story was the
"SevenTEEN people SHOT in local liquor store robbery"); the pointless ratios
showing the amount of debt "assigned" to each citizen or taxpayer, as if it all
must be paid off prior to a child being allowed to reach adulthood; the entire
opposition Republican Party turning against Keynesianism in favor of the
tortured populism of the tea parties; finally, the PIIGS, and their supposedly
self-evident example of the dangers of government overspending ...
I've made the counter argument to this many times - that in the circumstances
of the current economic maladies, government spending must step up to the plate
in order to provide the demand for product that the private sector has at least
temporarily pulled back upon.
The upshot is that the era of the massive trillion-plus US budget deficit is
probably coming to a close much faster than the Obama administration may have
wanted or needed. The $20 billion in mostly token budget cuts Obama proposed
early in the month is an example of this, but much bigger cuts will definitely
accrue with the more substantial gains the opposition Republicans are expected
to make in this November's mid-term elections.
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