Deficits and Stimulus Packages
Here is an extract from
commentary posted at www.speculative-investor.com on 9th January 2003:
The budget numbers reported
by the US Government are bogus because they include the Social Security surplus.
The real budget situation during any year can, however, be determined quite
easily by looking at the increase in the total Federal debt for that year.
This is because the Government's budget deficit (its total expenditure minus
its total income) is equal to the increase in its debt.
The below chart shows the
percentage change in the US Government's total debt during every financial
year from 1950 through to 2002, as well as the annualised increase in the
debt between the end of the last financial year (the year ended 30th September
2002) and 6th January 2003 (the chart's cut-off date).
During those years when
there is a budget surplus the percentage increase in the total debt will be
a negative number, that is, the line on the above chart will drop below zero.
This hasn't happened since 1960, although the steady decline in the rate
of government debt expansion between 1992 and 2000 almost resulted
in a surplus. When the stock and capital-spending bubbles burst during the
first half of 2000, though, there was a very sharp trend reversal in the
rate of growth of the Government's total debt burden. For example, the increase
in the total debt during the 2000 financial year was only $18B (a 0.32% growth
rate), but in the 2002 financial year the increase in the debt was $421B (a
7.25% growth rate). Furthermore, during the first 98 days of the 2003 financial
year the debt increased at an annualised growth rate of 9.29%. Assuming the
total Government debt continues to expand at its current rate during the
remainder of 2003, that is, assuming the US Government doesn't participate
in a war or implement a costly economic stimulus package, this year's real
budget deficit is likely to be around $600B.
With the above in mind let's
now think about the "economic stimulus package" proposed by President Bush
earlier this week. The 'package' will cost about $670B over 10 years, with
about $100B of that occurring during the first year, and comprises spending
increases and tax cuts. We've never met a tax cut we didn't like, but can
a government that is already running a huge budget deficit really stimulate
the economy by spending more or taxing less? After all, to pay for these 'stimulants'
the government must issue more bonds, which, of course, must be purchased
by someone. In effect, then, the package just recycles money from those who
will buy the additional government bonds to the recipients of additional
government benefits and tax cuts unless the additional government
bonds are monetised by the Fed or by private banks. That is, unless the central
bank and/or private banks purchase the additional bonds using newly-created
money.
If banks monetise the additional
debt then the result will be higher inflation (higher money supply growth).
Higher inflation would, in turn, probably reduce both the domestic and the
international purchasing power of the US$, that is, the cost of the 'package'
would be spread across all holders of US Dollars. In this case the 'package'
still wouldn't do much for real growth, but it would be bearish for the US$
and, by extension, bullish for gold.
One particular aspect of
the Bush stimulus package that has received a lot of attention is the plan
to eliminate the double taxation on dividends. If the markets were completely
rational then this plan would have no meaningful effect on the major stock
indices in the short-term because dividend yields are currently at miniscule
levels. Also, the average public company can't hike its dividend payout by
a significant amount at the present time (to allow its shareholders to take
advantage of tax-free dividends) because it is already paying out more than
50% of its earnings as dividends. In other words, the current low dividend
yields are a function of high stock prices, not a function of companies deciding
to retain more earnings than they probably should. Then again, if the markets
were completely rational the S&P500's dividend yield would not be below
2% in the first place.
In the short-term, what
really matters isn't whether the removal of the double tax on dividends is
important from a fundamental valuation perspective, but whether the removal
of this tax makes people want to run out and buy shares. In that respect,
prior to the reporting/leaking of the Bush stimulus package the stock market
appeared to be in the dying stages of a 'run of the mill' bear market rally
and it still seems to be in the dying stages of a 'run of the mill' bear market
rally. That might change, but at this stage the technical condition of the
market doesn't suggest that anything more positive is afoot.
It is worth noting that
while the proposed stimulus package won't stimulate much real growth, the
Bush team appears to have made yet another very smart move from a purely political
(Machiavellian) perspective. If the Democrats vigorously fight the proposed
package (something they have already indicated they will do) and are successful
in forcing it to be 'watered down', they run the risk of being blamed for
any serious economic weakness in the lead-up to the 2004 Presidential elections.
If they don't fight they run the risk of looking weak and irrelevant.
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