Wednesday, August 10, 2011

Federal budget update

The Federal budget numbers for July came in a bit better than expected, with the result that the 12-mo. deficit fell from $1.26 to $1.23 trillion. Thank goodness for small favors: the budget deficit is now running at about 8.2% of GDP, which is down from a post-War high of 10.4% at the end of 2009. The improvement is due to the fact that revenues have grown at just under 9% over the past year, while spending has grown by just under 3%.

Note to would-be optimists: the recently concluded budget deal would allow for spending to rise by at least 4-5% per year going forward (contrary to press reports, nobody was ever talking about actually cutting spending). Thus, the main hope right now for continued improvement in the budget outlook is for the economy to continue adding jobs, since a rising employment base is generating more income taxes. As the chart above shows, it is not unusual at all for revenues to rise at a fairly strong pace as the business cycle advances; it doesn't take higher tax rates to generate rising tax revenues—just a bigger economy will do the trick.

With the Fed in hyper-expansive mode, and given the inability of monetary policy to create growth out of thin air, what we are likely to see in the next few years is an acceleration of nominal GDP growth (e.g., modest real growth plus faster inflation). While this won't push living standards up by much, it should result in higher federal revenues as incomes rise and as people find themselves moving up to higher tax brackets. And of course, higher inflation will erode the burden of our $9.9 trillion of federal debt outstanding, even as it pushes Treasury yields and borrowing costs higher. So there is some reason to think that the budget outlook won't spiral out of control, as long as Congress takes steps in coming years to rein in the growth of entitlement spending (e.g., by raising the retirement age, by indexing social security payments to inflation rather than nominal wage growth, by privatizing social security, and by introducing market incentives to healthcare market and eliminating tax preferences and deductions).


Benjamin Cole said...

Please, Scott Grannis:

The Fed is not in a "hyper-expansive mode," or even an expansive mode. It has hit zero bound.

To be "expansive" the Fed would have to violate the laws of financial physics, and create negative interest rates. Or go to QE, and it is not doing that. So it is not being expansive. It is sitting dead in the water. It is sidelined by zero bound and its own determination to sit still. It is doing nothing.

Your commentary is becoming shrill!

If the Fed was in a "hyper-expansive mode", I would expect, oh say, something like strong inflation? Maybe above 5 percent, like in the Reagan years? When Volcker was Volcker?

If a central bank is "hyper-expansive" should not we see some inflation?

Wiemar Republic? Zimbabwe?

Why are USA real estate values going down, not up, in many markets? This is hyper-expansive? Why is the S&P 500 below 1999 levels, even nominally? A hyper-expansive Fed policy?

Why is the CPI-U for July 2011 just up 2.62 percent from three years earlier? That is hyper-expansion? That is 0.8 percent a year, btw, maybe the lowest rate for a three-year period on record, other than the Great Depression.

I fear the right-wing has developed an obsession over minute rates of inflation, and an unhealthy attachment to the symbols of money--gold, the value of cash--rather than true generators of wealth, which is business investment, innovation and entrepreneurship, and labor.


Then why do we look like Japan and not Zimbabwe?

Jeff said...

It is noy current inflation benji! It is growing inflation and the risk of further inflation through the current fed policies and massive government spending.

I fear the left-wing has developed an obsession with destroying this country. You can have "business investment and innovation" without the "symbol" (what the heck does that even mean) of sound money.

Fear is what is driving people NOT to invest.

Wake up. That coolaide is bad for you.

TradingStrategyLetter - Weekly Summary said...

Debt growth is (and has been) definately in a hyper-expansive mode for obviously too long. The battle of further excellerated increases vs further debt rating decreases(and reserve currency status)hangs in the balance. The Fed has more than 'violated' their purpose and responsibilities. The are in panic mode. Banks are sitting on tons of liquidity and are even charging certain depositors. I doubt that the markets want or would react positively to any further stimulus.

Public Library said...

Jeff, the only thing that would please Benji is if Heli Ben said he was going to raise the monetary base another few trillion worthless dollars.

The day after the markets digested Bernankes last gaff ploy to impose financial repression on the people for 2 more years, it all came crashing down.

More monetary malfeasance is not going to do us a darn bit of good.

TradingStrategyLetter - Weekly Summary said...

Just wait until the Tresury Market bubble bursts! It's gonna make 2007-08 look like a walk in the park!

Benjamin Cole said...


Explain why since the start of this year, the average value of a USA commercial mortgage backed security has dropped to 60 from 90 cents per dollar face value (see page C8, WSJ for you old fogies with newspapers, like me).

Dudes, we have no choice. We have to inflate the economy. If all these commercial loans go sour, it will make the residential collapse look mild.

Nihilism is not a policy.

Jeff said...


Nihilism? I'd say objective evaluation of Obama/Ben's attempts to inflate. It will not work. Period.

Federal stimulus of the economy will work about as well as Federal stimulus of the housing market (remember $8000 home buyer tax credits, $6500 move up tax credits, not to mention MBS and pushing interest rates to nothing!) and the car market (remember cash for clunkers).

You produce a short-term, unsustainable bump in demand.

My fear is we’ve seen the bump in the economy (like we saw in housing and autos) and now we are going to see the decline.

You CANNOT take $10,000 out of my pocket and give it to some unemployed union duffus in Detroit and have it stimulate anything!! As Scott said earlier (I think), it’s like taking water out of the deep end and pouring it back in the shallow end.

Freeze spending, freeze tax rates, freeze regulation, freeze the fed. Then see what happens!

PS Did you look up those Soviet aircraft carriers on the World Wide Web??

Benjamin Cole said...


Monetarists like Scott Sumner, David Glasner, and now even Martin Feldstein, Greg Mankiw and others are not calling for federal stimulus. They are calling for a Fed to stimulate the economy. From their point of view, federal spending is neither stimulative or restrictive.

They are calling for a Milton Friedman-esque approach. If you have hit zero bound (we have), if the economy has lots of slack (we do) if asset values are falling (ours are), if debt are heavy (yes), then you need to inflate out it with QE.

Japan did not listen to my hero Milton Friedman. Neither did the USA.

Aircraft Carriers:

Yes, see my answer, in previous post. The Russkies were bad guys, but they had no true aircraft carriers. And now they have none. They sold one helicopter carrier to the Chinese for a gambling casino.

Do you think the Russkies are better off, or worse off, today for funneling money that used to go into a huge military instead into their new private sector?

William said...

Having practiced medicine for 30+ years in a hospital setting with contact with many doctors of most specialties and with hospital administrators as a Chief Pathologist, I must insist market incentives will do very little to control costs in health care.

Firstly, doctors are the ones who write the orders for tests, radiology studies, medications, hospital admissions and all kinds of therapies. Since the 1970s hospitals and indeed medical specialty organization have had various "cost containment" programs. They were not very effective because patients want the BEST treatment and doctors want to provide the BEST treatment.

I once had hope that younger doctors would be more cost conscious - I had heard that medical schools were trying to train doctors in the most cost effective ways to practice their specialties. However,I saw precious little evidence that the younger doctors were any different.

Most physicians think that by ordering more tests or ordering very special radiology studies that they are giving their patients the best treatment.

The same way with prescribing antibiotics. They are "educated" by so called "drug detail" persons who come by their offices with presentations, literature and free samples. The "detail persons" today are very bright, very attractive and very personable women. The physician wanting to be up_to_date too often prescribes that latest and most expensive antibiotic or other drug when an older one would do EQUALLY well. In fact the newest antibiotics should only be used for serious infections in which the bacteria is resistant to older medications.

To carry this even further, the drug detail person's "sales effectiveness" is monitored by the drugs companies which receive data from local pharmacies about how well their drugs are selling versus their competitors by zip code. This feedback is used to motivate and to evaluate the sales rep.

Health care is distorted by the basic fact that physicians order all the tests and treatments but don't of course pay the bills. In general, there are no market feed back forces which effect the behavior of the person most responsible for most of the cost - the physician.

And most patients will never be so well educated that they can decide what tests or treatments are best for them. When one is acutely ill or has just received a life threatening diagnosis, most patients are not motivated to research cost effective treatments. They and their family members just want good old dad, or mom or sister to get well soon.

I - and many retired physicians I know - think that a single payer system such as Canada's is the only solution which will result in the cost effective practice of medicine. I have spent three months in Canada in recent years and every Canadian I have spoken to like their system. It is NOT perfect but works quite.

Incidentally most other advanced countries have per capita total health care costs which are 25 to 50% lower than the U. S. - so we are talking a large savings here.

Numerous WHO and other comparative studies demonstrate that the U. S. doesn't get better health for the extra money spent. In fact, in such comparisons the U. S. now ranks somewhere between 15 to 32 from the top depending on whether it is infant mortality, maternal mortality, survival with breast cancer, survival from one's first heart attack, etc.

Furthermore the expense of health care in other countries is not born by corporations but by a general health tax to which all contribute. Such a single payer system in the U. S. would dramatically lower corporate costs.

Public Library said...

Plain wrong logic Benji. The Fed can only do harm via incentives for malinvestment. The Fed never was nor never will be needed.

The irony is everyone knows sometimes the best thing to do is nothing. However, our govt and quasi govt never heed the advice.

I agree with Eff. Actually, back in 2008 I called for the Fed to normalize rates between 3.5-5% and let the under-capitalized and over-invested fail. Let the investors and entrepreneurs with dry powder redirect the capital into more profitable endeavors.

Sadly people were sold armageddon but in reality we were talking a 2 year drought and then a massive rebound.

Instead, we will get a decade or two of intervention and failed technocratic tinkering. You cannot manipulate humans like lab rats.

Steve K said...

Why is it when prices go down at Walmart, or say home depot, it's a positive. When home values go down it's a negative.

The problem is, banks are holding worthless mortgages and govt. policy is short circuiting the market clearance mechanism. We have death by 1000 cuts. All this angst to save stodgy old banks that utterly ruined themselves.

Jeff said...

I am no expert, but I doubt that MF would have supported all the fed actions...including qe 1, 2, and beyond. I offer the following:

More revolutionary still was Mr. Friedman's proposition that monetary policy can affect real output only in the short run. The Phillips curve works only for a few months. Long-term economic growth depends on real factors like innovation, investment and entrepreneurship.

This proposition "is universally accepted today by monetary economists," Mr. Bernanke said. "When Friedman wrote, however, the conventional view held that monetary policy could be used to affect real outcomes -- for example, to lower the rate of unemployment -- for an indefinite period."

That belief led to terrible economic policy. Trying to maintain full employment, the Federal Reserve of the 1970's pumped out money faster than the real economy grew. A result, Mr. Bernanke said, was the "Great Inflation of the 1970's -- after the Great Depression, the second most serious monetary policy mistake of the 20th century."

Today, most macroeconomists also accept Mr. Friedman's most famous proposition -- that inflation is always a monetary phenomenon. Contrary to what I learned in macroeconomics class, "cost push" inflation was a myth. Pay and price increases did not drive inflation; they reflected it. Americans wanted higher nominal wages and prices to keep up as the real value of each dollar declined.

I doubt that MF would have promoted "inflating" our way to prosperity as you suggest.

Jeff said...

MF also would have scoffed at too big to fail and the resulting government actions based on that premise.

MF advocated freedom and limited government. Obama and company would label him a tea-party terrorist.

Jeff said...

And while we are at it, MF would have been against Obama care too!

Jeff said...

But maybe Scott can weigh in on the question what would Milton do?

mmanagedaccounts said...

Scott, anyone:

Do you see any evidence of a global or European liquidity squeeze? GaveKal has been warning of such a development for the past few weeks.

One of your graphs showed a major spread in European swaps. Thanks.

Scott Grannis said...

Re what would MF do: I think there is no way on earth he would have approved of the Fed announcing that its target interest rate would hold for two years. Especially considering M2 growth is accelerating.

Scott Grannis said...

Re European liquidity: Euro financial markets are clearly under stress, but I'm not sure that it is because of a liquidity squeeze. 2-yr swap spreads are trading at 80 bps, which is moderately high and indicative of problems in the banking industry. But not catastrophic conditions. The Euro is reasonably strong against the dollar, but has fallen just like all currencies against gold, so no sign of a shortage of euros in the world. The ECB is definitely tighter than the Fed, but short rates are still very low in Europe. I think the problems have more to do with fears of a Greek default that then spreads to Italy and perhaps other countries. If defaults are big enough then the banks are in real trouble. You can't fix that kind of a problem easily. If anything, the ECB appears to want to monetize debt (i.e., print a lot more money) to alleviate the problem.

Mike Eliason said...

Scott, I'm curious what you think about the odds of a double dip recession. Most of the pundits think it's a foregone conclusion. Then again, most of the pundits are usually wrong!

Scott Grannis said...

I see no signs of a double-dip recession.

Benjamin Cole said...


Thanks for the link. As I said, the Russkies never went in for full-on aircraft carriers, but did build a helicopter carrier, and a handful of aircraft cruisers, now all gone.

"She was originally commissioned in the Soviet Navy, and was intended to be the lead ship of her class, but the only other ship of her class, Varyag, was never commissioned and was sold to the People's Republic of China by Ukraine under the condition she would never be refitted for combat."

BTW, China's sole aircraft cruiser (not carrier) is a 25-year Russian vessel. They bought a used ship from the Russkies, and have re-outfitted it. Imagine that. Now China has a military that knows how to stretch a dollar. We didn't we do that?

I can assure you of this: The Pentagon will say we could not buy the 25-year-old Russkie warship as it was not really adequate, it was inferior, obsolete, etc etc.

But in the hands of the Chinese, it becomes a fearsome new development.

The world's best PR shop is in Washington DC. The Pentagon.

Benjamin Cole said...

Friedman and Fed policy.

I don't know what Friedman would do on interest rates, but he was pretty clear that what Japan needed in these circumstances was steady QE until inflation resulted.

It can't get any more clear than his own words:


Lori said...

Tax policies have always favored real estate. So, does is not look like the Fed is helping to save RE by keeping rates ultra low for the next two and a half years?

Since banks have plenty of it on their books, and by keeping rates ultra low, isn't this a continuation of the bailouts? As it helps banks slowly and surely sell off the inventory without much in the way of interest costs?