obama’s newer deal · 2009/1/17 · - 3 - obama’s newer deal special report revenues fall, the...

Obama’s Newer Deal

A special report from the editors of The Casey Report

Special Report

© 2009 Casey Research

www.caseyresearch.com- 1 -

Special ReportObama’s Newer Deal

From an economic policy point of view, the world shifted on its axis in 1933. The New Deal, the separation of the dollar from the gold standard, and the federal government’s lasting embrace of economic intervention separated everything that came before from everything that followed. In 1933, the idea of an economically-passive, laissez-faire American government disappeared forever.

Now faced with an economy that places America precariously on the edge of a cliff, Barack Obama is planning a recovery using every available device that has been contrived in the last 75 years of economic fiddling. The stakes, of course, are enormous.

It remains to be seen if the plan will save us from the brink. The world is a different place than it was in 1933. Economic systems are far more complex, and sitting in the corner is an 800-pound gorilla of astonishing debt — federal, state, local, and personal. However, it is certainly useful to compare the economic environment, as well as the Plan itself (to the extent that we know what the Plan is), to get a glimpse into the future.

FDR’s New Deal— a Refresher

Never before FDR’s New Deal had the federal government inserted itself so vigorously into roles previously assumed by the private sector. Beginning in 1933, with the passage of New Deal legislation and the confiscation of monetary gold, the American economy entered uncharted territory.

Much of Roosevelt’s comfort in his approach derived from John Maynard Keynes, who fervently believed that government had an obligation to intervene in periods of recession with deficit spending. He pleaded with Roosevelt to spend his way out of the depression — and Roosevelt obliged.

The First 100 Days

After a decisive victory in the U.S. presidential election of 1932, and with a Democratic Party sweep of congressional elections across the nation, FDR entered office with unprecedented political capital. Americans of all political persuasions demanded immediate action and relief, and it should come as no surprise that special interest groups wanting to be placed at the head of the line hounded him from all sides.

Roosevelt responded with a remarkable series of new programs in the “First 100 Days” of the administration. During that time, Congress passed a broad range of banking reform laws, emergency relief programs, work relief programs, agricultural

programs, and industrial reform: an alphabet soup of agencies meant to bring relief to as many Americans as possible. Rather than a comprehensive plan, they were individually - conceived programs, which sometimes solved one problem, only to create another — a kind of governmental Whack-a-Mole.

There was the Civilian Conservation Corps •(CCC), which put 3 million young men to work on environmental projects nationwide.

There was the Tennessee Valley Authority (TVA), •intended to bring relief to one of the hardest-hit areas of the country. By constructing dams and hydro- power plants, the program created cheap electricity, cheap fertilizer, and thousands of acres of newly-drained farmland.

There was the Agricultural Adjustment •Administration (AAA) to assist farmers by supporting prices for livestock, cotton, corn, wheat, rice, and milk. It also paid farmers to reduce production in order to drive up prices. (Regretfully, much of the subsidy went to the landowners rather

... they were individually- conceived programs, which

sometimes solved one problem, only to create

another — a kind of governmental Whack-a-Mole.

(continue)



than the sharecroppers, who used the money to buy farm equipment that eliminated the need for the sharecroppers, sending thousands into deeper poverty.)

There was the National Recovery Act (NRA), which •attempted to create fair competitive practices and set minimum wages and maximum work hours.

And there were many more.

And then there was the Second New Deal in 1935. Its programs included:

Works Progress •Administration (WPA), which provided government employment on an unprecedented scale for the purpose of building highways, buildings, and bridges, as well as reforestation, urban development, and more. By 1943, when it officially terminated, the WPA had employed 8.5 million Americans. Given its tremendous size, it was inevitably plagued by waste, graft, and favoritism.

The Social Security Administration, too, was part of •the 1935 legislation.

From 1933 until the beginning of World War II, the New Deal legislation cost, in total, $500 billion in today’s dollars. As a lesson in macroeconomics, it reached a less than satisfying conclusion; we’ll never really know what the outcome would have been had the war not intervened. But we do know that in just a decade, federal government debt as a percentage of GDP rose a whopping 28%, from 16% in 1929 to 44% in 1939.

Obama’s Newer Deal

At the writing of this report, House Democrats have released a proposed stimulus plan that totals $825 billion — subject to certain change once it passes through the legislative process. The plan covers five areas of spending

and tax breaks: health, education, infrastructure, energy, and support for the unemployed and the poor. As Larry Summers, who will lead the Obama White House National Economic Council, puts it, the plan “represents not new public works but, rather, investments that will work for the American public.”

Summers described job creation as a “key pillar” of the plan. “More than 80 percent of these 3 million jobs will be in the private sector, including emerging sectors such as environmental technology.”

Faced with its own rising costs, flat or falling revenue, and an uncertain future, the private sector is likely to provide little or no help. Why would a $3,000 tax incentive entice any employer to hire a $30- or $50,000 employee to build product it can’t sell? It

seems more likely that, should the administration want business to create 3 million jobs, it is the administration that will have to pay for them.

Summers goes on to say that the plan “relies on both government spending and tax cuts to raise incomes and promote recovery.” Obama advisor David Axelrod reinforces the notion of economic stimulus: “People need money in their pockets to spend. That’ll get the economy going.”

Will it? We think not. What the economy needed in 1933, and what it needs even more so now, is vast deleveraging: using assets to pay down debt. Like a household with finite income and too many credit cards, there comes a time when the piper has to be paid. Getting more credit cards only temporarily makes the problem go away, and surely makes it worse.

Details of the Recovery Plan as we know them, as well as the rest of the planned 2009 expenditures, are listed at the end of this report (see Appendix 1). The result of this spending will be a deficit that, by growing consensus, will very likely exceed $2 trillion in 2009 alone. If tax

What the economy needed in 1933, and what it needs even more so now, is vast deleveraging: using assets to pay down debt.

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revenues fall, the deficit may even exceed the total U.S. budget of 2008: $2.9 trillion.

We simply can’t afford to borrow that much money. In fact, we will be unable to borrow that much money.

Here’s what we know about the budget deficit for 2009:

The base case, as published by the Congressional Budget Office, includes only those items that have been legislated. This ignores potential updates, for example, additional spending for the wars in Iraq and Afghanistan and, most importantly, Obama’s new stimulus package.

The Office of Management and Budget (OMB) baseline deficit published January 7, 2009, starts out at $1.186 trillion.

They admit there’s much more. Here are the additional outlays that will have to be borrowed by the U.S. Treasury:

The Obama stimulus package is, at present, $825 billion. That alone gets the 2009 deficit over $2 trillion.

The $700 billion of TARP is only entered at $180 billion of outlays by estimating the present value of all future cash flows. OMB assumes the $700 billion TARP will be spent, but still claims that they are investing in some profitable ventures. Even if that is the case, they will have to borrow the entire $700 billion to buy whatever troubled assets or banks’ equity they deem necessary. So add the total of the TARP accounting for $520 billion more.

Bringing the total to $2.53 trillion.

For economic assumptions, the OMB recognizes the

economy slowing:

“In addition, economic developments have reduced tax receipts (particularly from individual and corporate income taxes) and boosted spending on programs such as those providing unemployment compensation and nutrition assistance as well as those with cost-of-living adjustments.”

According to the assumptions in the OMB’s projections, the GDP in 2009 will be flat compared to last year, and the average 3-month T-bill is estimated at only 0.2%.

But interest rates are very likely to rise, because with the vastly expanded money supply, inflationary pressure must eventually prevail, and higher interest rates will necessarily follow. Furthermore, the economy is likely to get even worse, leaving us with lower tax revenue. At the bottom of the Great Depression, tax receipts had fallen 50% from prior levels. Anything approaching that level in the current slowdown would blow an even bigger hole in the budget.

On Fannie and Freddie, the cost is recognized as only $200 billion, but those two institutions, now de facto extensions of the U.S. government, have $5 trillion in guarantees:

“Recognizing the cost of the takeover adds about $200 billion (in discounted present-value terms) to the deficit this year, reflecting the long-term net cost of the more than $5 trillion in credit guarantees issued and loans held by those entities at the start of the fiscal year.”

The purchase of mortgage-backed securities requires cash and borrowing by issuing new Treasuries, but it is not considered a loss to the budget because they are getting the asset:

“Additionally, the Treasury is purchasing (continue)

If the tax revenues fall, the deficit may even exceed the total U.S. budget of 2008:$2.9 trillion.



mortgage-backed securities from the private market; CBO assumes that such purchases will total nearly $250 billion this year, thereby necessitating additional borrowing of a similar amount (although the budgetary impact of the purchases, shown as an estimated subsidy amount in 2009, is relatively small).”

There is nothing mentioned about the new healthcare promises. Try $300 billion as a down payment.

The tab for borrowing for next year, so far:

$1,186 Base $825 Obama stimulus $700 - 180 = $520 TARP fully accounted $300 Healthcare $250 Accounting for MBS $100 War supplement $100 AMT, autos, or …

= $3 trillion + = 21% of the Gross Domestic Product = more than the total 2008 budget

Slowly, the news headlines are beginning to grasp the reality of the coming deficit. Even Obama said in a speech on January 6 that “we can expect trillion-dollar

deficits for years to come.” Hopefully, many of the promises and programs that comprise this enormous cost (see Appendix 1) will not be fulfilled.

What’s Different This Time Around

In 1933, the U.S. was the manufacturing hub of the world, rich in natural resources, self-sufficient in oil. States were solvent. And while individuals held mortgages on their homes, they also had savings. The credit card was decades away.

Total federal debt in 1933: $360 billion in 2008 dollars. Total federal debt in 1933 as percent of GDP: 40%

Total federal debt in 2008: just under $11 trillion. Total federal debt in 2008 as percent of GDP: 70%

Now it looks like our government would like to add close to $3 trillion to that in 2009 alone.

And the $11 trillion is only part of the deficit. In a speech to the National Press Club, Comptroller General David Walker noted the release of the 2007 Financial

Report of the United States government, saying the “federal government’s total liabilities and unfunded commitments for future benefits payments promised under the current Social Security and Medicare programs are now estimated at $53 trillion, in current dollar terms — up from about $20 trillion in 2000.”

This “translates into a de facto mortgage of about $455,000 for every American household, and there’s no house to back this mortgage,” Walker said. The Medicare program represents $34 trillion of the “fiscal gap,” with

the prescription drug benefit along equaling about $8 trillion of the $34 trillion Medicare total.



“Generations of Americans will be paying the price—with compound interest — for this new entitlement benefit,” Walker noted. “In other words,” Walker said, “our government has made a whole lot of promises that, in the long run, it cannot possibly keep without huge tax increases.”

Where, exactly, is the money going to come from? China? Japan? The Middle East? Europe? Not likely. Every country on the planet is increasingly strapped for cash. Whether as a result of reduced exports (China) or declining commodity prices (Middle East & Russia), the fact is that there will be a lot less excess cash available for investment in the U.S. in the coming years. In addition, while the lion’s share of bailout money worldwide is being spent by the U.S. (see Appendix 2 for details), most of the developed world is anteing up boatloads of cash to support domestic economies:

EU: $2 trillion + China: $586 billion Russia: $150 billion

Further, Obama’s personal pledge to give “investment deficit” priority over “budget deficit” cannot be welcome news to the holders of foreign dollars. Sooner or later, their willingness to continue to both hold the dollars

they own and continue to buy more will disappear, particularly in light of interest rates that are now effectively zero.

The time will come, and probably during 2009, that the only way the U.S will be able to fund its deficits

is to create money by printing it. The Treasury will have to sell bonds, and, in the absence of foreign buyers, the Fed will have to print the money to buy them. The consequence will be runaway inflation, increasing interest rates, recession, and inevitable tax increases on all Americans.

Using Federal tax revenue as a percent of GDP to measure the general burden of taxation, the toll was only 3.2% in 1932, but it doubled to 6.8% by 1940. In 2007, Federal tax already accounted for 18.6% of GDP. Could it double again? Probably not — it would be political suicide. Politicians

much prefer increasing debt to increasing taxes. But tax increases are inevitable in the light of skyrocketing funding requirements from social programs and falling tax revenues due to the recession, combined with increasing national debt servicing costs. A federal tax burden of 30% or more is a possibility in future years. Add state and local taxes, and the total national tax burden could exceed 40% of GDP. With taxation to that degree, incentive for entrepreneurship and economic success will evaporate, jobs will be lost, and the brain drain experienced by some high-tax European nations in past decades will become reality in the U.S.

The era of runaway U.S. consumerism is over, and the piper is demanding payment for past American overindulgence — at a time when the U.S. government itself is broke. The economy’s eventual turnaround will only occur after the debt that permeates the economy is substantially reduced. It’s going to be a painful process.



What Now?

The truth is, there is no catbird seat for investors. At Casey Research, we believe that a widespread market recovery to previous levels is very unlikely any time soon, and that the slowing economy, rising interest rates, and severe downward pressure on the dollar will conspire to make profitable mainstream investing very difficult.

In the inflationary cycle that is coming, many currently undervalued commodities will provide very significant hedges against the devaluation of the dollar. In fact, the supply destruction that has followed the credit crisis and current deleveraging is already starting to create shortages.

While mainstream stock analysts are urging their clients to buy stocks and take advantage of bargains, we believe that we have only seen the first wave of casualties in the markets. Black Tuesday was on October 1929, yet the markets bottomed almost three years later, in July 1932 — and it took until 1954 to recover to their pre-depression levels. We are not in the middle of a cyclical recession, and most sectors of the economy will see significant further declines. Most stocks and bonds will see their value decline as inflation reduces corporate profits, and as climbing interest rates affect consumption and raise costs.

But, as always in times of crisis, investment opportunity will exist. And as always, the best opportunities will be not where the herd goes, but where the well-informed go. In a political economy, there will be plenty of opportunities to take advantage of distortions introduced by misallocation of assets by government; certain sectors will boom while most others collapse. In the face of the current turmoil, the Casey Research team of experts has identified several significant upcoming bull markets.

We invite you to take a look at their monthly research in The Casey Report, the flagship publication from Casey Research. There you can follow the unfolding of the Obama Recovery Plan and its consequences,

featured in our new regular column, “Obama Watch.” Most important, it will provide you specific advice about developing trends, and specific investment moves you can make to profit during the coming Greater Depression.

In contrast to most mainstream brokerage firms, Casey’s unbiased analysis is conducted for the strict benefit of subscribers; there are no underwriting fees that could affect objectivity. Casey’s team of economists and analysts leaves no stone unturned in its quest for opportunity, whether it is shorting the markets that will be next to collapse or looking at the sectors and companies that will emerge as the winners in the current crisis.

If you are not yet a subscriber, now is the right time to take advantage of our no-risk trial offer. See details of a risk-free subscription to The Casey Report here. (http://www.caseyresearch.com/casey-services/the-casey-report) We suggest that you don’t put it off.

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Appendix 1 Estimated Cost of Bailout Programs Announced in 2008

Breakdown of $10 + Trillion Government Bailouts

Federal Reserve Programs Commitment ($ Billions)Commercial Paper Programs $1,862

Term Auction Facility $1,600

Other Assets $606

Finance Company Debt Purchases $800

Money Market Investor Funding Facility $540

Citigroup Bailout $291

Term Securities Lending $250

Term Asset-Backed Loan Facility $200

Other Credit Extensions $123

Discount Window $142

Bear Stearns Assets $29

Overnight Loans $10

Federal Reserve Total $6,453

FDIC ProgramsLoan Guarantees $1,400

Guarantee to GE Capital $139

Citigroup Bailout II $10

FDIC Programs Total $1,549

Treasury Department ProgramsTARP $700

Stimulus Package (2008) $168

Treasury Exchange Stabilization Fund $50

Tax Breaks for Banks $29

Treasury Department Total $947

FHA ProgramHope for Homeowners $300

FHA Program Total $947

Subtotal $9,249

American Recovery Reinvestment Bill (2009) $825

U.S. Government Total $10,074 Sources: Federal Reserve; FDIC ; FHA; Treasury Department; Bloomberg.com; CNNMoney.com

By comparison, the inflation (CPI)-adjusted cost of World War II was $4,100 billion.



Appendix 2 Obama’s Long-Term Platform

Obama’s long-term platform includes calls for a hike in the payroll tax cap, new pro-union legislation, blocking insurance companies from denying coverage, a home foreclosure bailout fund, a cap on payday loan interest rates, carbon cap-and-trade, tripling the size of AmeriCorps, doubling foreign aid contributions, and increasing the size of the military by 92,000. And that’s just for starters. Inherent to his proposals are plans to spend:

$60 billion toward a “National Infrastructure Reinvestment Bank” that would finance high-speed railways, improved energy grids, and other projects.

$15 billion a year at least for basic research

$250 million per year to create “a national network of public-private business incubators.”

Unspecified amounts (probably in the billions) for various educational programs

$150 billion to “advance the next generation of biofuels and fuel infrastructure.”

$50 billion for a “Clean Technologies Venture Capital Fund” to fill the gap between discovery and commercialization and subsidize investment in “socially productive activities.”

$50 billion to cut “extreme poverty around the world in half by 2015.”

Unspecified amounts, most likely trillions in unfunded liabilities, to “make available a new national health plan to all Americans” for which no applicant can be turned down and which will be comprehensive.

$1 billion for “transitional jobs and career pathway programs.”

$50 billion to “move the U.S. health care system to broad adoption of standards-based electronic health information systems.”

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obama’s newer deal · 2009/1/17 · - 3 - obama’s newer deal special report revenues fall, the...

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