Sunday, October 18, 2009

2009 Federal Deficit Surges to $1.42 Trillion

Associated Press (AP):

“WASHINGTON – What is $1.42 trillion? It's more than the total national debt for the first 200 years of the Republic, more than the entire economy of India, almost as much as Canada's, and more than $4,700 for every man, woman and child in the United States.”

-MARTIN CRUTSINGER, AP Economics Writer, 10/17/09

Let’s take a look at what $1.42 trillion really is.

According to the Bureau of Economic Analysis (BEA) of the Department of Commerce , the GDP of the United States, or what the media roughly calls “The Economy” in the second quarter of 2009 was $12.901 trillion. With a little division, we can easily find that the federal deficit as a percentage of GDP is approximately 11%.

Put in those terms, the deficit doesn’t look thaat bad. I’m not a bull currently, but it is funny when the media exaggerates.

Moving on, further down in the article it does write out the troublesome quintessential bear argument which I found a bit more interesting:

“If those investors [such as China] started dumping their holdings, or even buying fewer U.S. Treasurys, the dollar's value could drop. The government would have to start paying higher interest rates to try to attract investors and bolster the dollar.

A lower dollar would cause prices of imported goods to rise. Inflation would surge. And higher interest rates would force consumers and companies to pay more to borrow to buy a house or a car or expand their business.”

Yikes. People are finally looking into a repeat of Paul Volcker, chairman of the Federal Reserve in the late ‘70s, who in order to combat inflation had to increase the federal funds rate to more than 20%. What a lot of people aren’t getting right now is that the Federal Reserve is going to definitely increase interest rates to combat inflation and reign in the monetary supply which it has let loose rampantly.

The big question is just how fast the Fed will increase interest rates and just how high. My guess is that it’s going to be high, to counteract this period of near 0% interest rate. This, counter-intuitively, won’t necessarily cause the economy to stagnate considerably if people expect the increase in interest rates. What’s more important is that the Fed increase rates in a manner that plays well with the expectations of people and also at a speed that doesn’t create a shock to the economy.

If the Federal Reserve either increases interest rates too fast or too high, expect another big recession. If the Federal Reserve increases rates too slowly or too low, expect another big bubble. Or, if the Federal Reserve does its job and Ben Bernanke is successful, expect a steady economy where you get what you expect.

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