No Runny Eggs

President Barack Obama has pledged that his administration would be the most ethical and transparent that the US had ever seen.   Key to his pledge of transparency was the legislative and budgeting process.   In fact, David Axelrod and other Obama spokespeople have been touting the candidness of the President’s budget with comments such as:

“The president is determined to treat the American people as adults and be straight-up about what we’re facing and what we need to do to move forward,” said David Axelrod, senior advisor to the president.

As a blogger, I suppose I should be happy when political types make absolute statements about issues that aren’t absolute.   It becomes easy fodder for the next post.   However, as a citizen, it annoys me greatly because it leaves me trying to decide if the person saying it is either stupid enough to believe or think that I will be stupid enough to believe.   Oh, whatever.

You can see the detail of the “most transparent budget ever” here.

A quick and by that I mean no more than 15 minutes, review of the transparent budget reveals a few issues:

• Contrary to Obama’s claims that there would be no tax increases until the Bush tax cuts expire, you will see on page 123 that the increase of the capital gains rate of “rich people” will begin in FY 2010.   For those of you unfamiliar with a fiscal year, it would mean that those tax rates could go into effect on 10/1/09.   I suspect for implementation reasons they will actually go into effect on 1/1/10 but that is still a year earlier than the tax cuts are due to expire.
• While President Obama is lauding himself for reducing deficits to “merely” $500 billion by the end of his first term, he’s not telling you the whole story.   On page 133 you can see what is happening to debt.   In 2013 when Obama says his “transparent” deficit is on $500 B, his total debt increase is $925 B!   In fact, he proposed 10 year budget shows that debt will increase at a rate close to $1 Trillion each year past Obama’s first term!
• Page 114 shows the projected total debt and projected GDP.   As I told you here, the GDP figures have as much reality as unicorns and mermaids, they’re too high.    On the flip side,  if Obama spends all he says he will, the debt is likely under forecast.   Rater than nitpicking, let’s take the “transparent” numbers at face value.   If debt comes to be as Obama’s forecast has it, we will for the first time since WWII have debt that is greater than our annual GDP.    In  FY 2008 our debt was 70% of GDP.    Obama’s plan shows us increasing debt as a % of GDP every year of his forecast reaching 101% of GDP by 2019!    This after increasing revenues (taxes and such) 76% during that same time frame!  
• Finally, US debt is only partially held by the public.   At the end of FY 2008, $5.8 T of debt was held by the public.   Approximately $3 T of that amount is held by foreign entities.   Somehow the Obama administration has concluded that while GDP will increase just 60% they will convince foreign entities to increase their purchasing to support a 230% increase in debt.   If that’s not miraculous enough, they’ve added the extra difficulty of financing all of that debt with rates that are below the historical norm!   The Obama budget assumes that the long term rate for the 10 yr. Treasury is 4%.   A look at this table shows that since 1960, the 10 yr treasury has only averaged 4% or less 3 times.   While not statistically accurate, a simple average of the rates for the past 48 years is nearly 7%.   I don’t care who’s doing the rounding, that doesn’t get close to 4%!

It looks like we will continue with the redefinition of  words for the New Obama English.   From now on, “Transparent,” when used by someone in the Obama administration will mean:

“Truth”, not based in reality but if not questioned and sprinkled with lots of hope, could fool that portion of the populace for whom “it feels right.”

Between,  his Tuesday night address to Congress and a speech today, President Obama has revealed his budget proposals not only for the coming fiscal year but in large part, for the length of his Presidency.

First, let’s deal with the issue that is budget proposals are somehow different than those provided by previous administrations.   They aren’t.   While there have been different methods of presenting the budget such as continuing operations versus special appropriations for Iraq, there has been one constant comparable in all of them; the increase in debt required to service them.   Put in other words, each of the fiscal years, regardless of how the budget was compiled, can be compared based upon the year end debt that they created.

When President Bush took office, the US debt was approximately $5.7 Trillion.   At the end of Bush’s first term, total debt was $7.4 T, an average increase of $350 Billion per year.   During Bush’s second term debt ended around $10.6 T with $1.6 T of that coming in the last year alone.   If you take out the last year the average increase was $500 billion per year and that was while paying for the Iraq war.

Enter President Obama.

I won’t pick apart what he’s done to the deficit this year, except to say that while Obama is quick to talk about what he “inherited,” he’s not so ready to discuss that he is just as responsible for the $1.75 T projected deficit of this year as Bush is.   After all, wasn’t it than   Senator Barack Obama who assured us that he was “just a phone call away” working to persuade Congress to pass the $700 B TARP.   And wasn’t PEBO who was consulted on the auto bailout?   Wasn’t it also PEBO who made the ultimate decision on requesting the second tranche for Tarp?   Finally, as President Obama wasn’t it he who led the way to the stimulus package, the largest single expenditure ever in the US?   The only people who believe that this deficit was “inherited” are those who worship at the altar of Obama or simply chose to be ignorant.

Moving past ’09, President Obama’s budget plan will optimistically, increase the US debt by a minimum of $1T in the first two years and $500 B in the second two years of his administration, a total of a $3 T increase in debt in only 4 years!   Enormous deficits especially when you consider that  Obama will no longer have a war to finance, he will not have to spend to “reclaim the economy” after this year and the previous CBO budget had projected that the deficits during this same time frame would be “merely” $1.7 T!

I noted that the deficits that Obama is projecting are optimistic.   In fact, the deficits are likely not even nearly achievable.   Why do I say that?   After all, isn’t part of Obama’s plan to increase taxes on “the rich,” close loopholes and find other ways to raise tax revenue?   Yes he is.   However, Obama has overlooked one very basic economic fundamental.

Back in June of last year I introduced you to Hauser’s Law.   Hauser’s Law, simply put, says that no matter what you do to tax rates, how you open or close tax loopholes, whether you increase one type of rate and decrease another, tax income tends to equalize around 19.5% of GDP.   Nobody can explain for certain why this happens but, when you see a trend that holds over nearly 60 years, across numerous administrations, spending and taxing philosophies, if it isn’t a law, it should be made one.  

What’s Hauser’s Law got to do with Obama’s deficits?   Simple.

Obama is banking on a rapid return of income that he can tax.   Obama’s budget assumes that growth will be negative 1.2% this year returning to a robust 3.2% next year.   The CBO which is in line with many private economists, believes growth will be negative 2.2% this year and positive 1.5% next year.   Doesn’t sound like much until you realize that Hauser’s Law says that each percentage point equates to about $28 B of missed tax revenue and that it compounds over the time frame.   If Obama is off by just 1% in each of the years that translates to a deficit understatement of over $130 B (remember when a Billion used to be a big number?).   If the CBO is right and Obama wrong, the first two years alone will translate to over $130 B with additional shortages in the last two years because of a lower GDP run rate.  

As an aside, isn’t it ironic that Obama’s budget is highly optimistic in projecting revenue when he’s been telling us for months that this is the worst economic downturn since the Great Depression?   If you look at what happened to GDP the years following the depression Obama is not just optimistic, he’s delusional!

On top of the overly optimistic growth rates is another problem for Obama’s tax revenue.   Obama has committed to significantly increasing a number of taxes to increase the revenue.   He has even proposed a new tax, a carbon tax to generate significant amounts of new revenue.   Economists of all persuasions will tell you that increasing taxes will reduce overall GDP.   Increasing taxes on something will always cause less of that something to be consumed or created.   Don’t believe me?   Just take one look at what is happening to cigarette consumption as taxes continue to be increased on them…it’s not going up!   Now we can discuss what the elasticity of that change is i.e. do you have to double the taxes before GDP is impacted or will a 1% increase in taxes impact GDP.   However, Hauser’s law says that the elasticity discussion is moot.   Hauser’s Law will say that the very fact that less GDP is generated will result in less tax revenue being generated regardless of what the actual rates are.

Everything Obama does is for the optics or in how the action supports his ideology.   It’s too bad that he doesn’t approach issues from an actual intelectual honesty and curiousity.   If he had in the case of his budget, he may have learned the core fact from Hauser’s Law:

Putting it a different way, capital migrates away from regimes in which it is treated harshly, and toward regimes in which it is free to be invested profitably and safely. In this regard, the capital controlled by our richest citizens is especially tax-intolerant.

Contrary to Obama and Gibb’s protestations that this is the first budget with “full disclosure,” this is a budget that is built on more optimism than all the “Hope” in Obamaland.   The budget will fail on any measure of fiscal integrity and responsibility.   My hope is that the country doesn’t fail economically along with it.

What’s that I hear?   it’s the big sucking sound created by the Federal Government mucking around in things they know nothing about.   First on the list:

AIG Needs More Help After $60 Billion Loss

AIG, as you may remember, was the first “too big to fail,” after the Feds got nervous after Lehman hit the dust.   After two bites at the apple, AIG got a total of $150B government support.   Reports are that after several sales of profitable pieces of their company, AIG has gotten their outstanding balance down to $35B.   It’s believed that AIG will report the largest loss ever by a US company tomorrow at $60B.   Please note that we (and by we I mean the Federal Government) owns 80% of AIG so there should be no surprise when money is “shovel ready” to keep them afloat.

Next:

U.S. Eyes Large Stake in Citi

Citigroup Inc. is in talks with federal officials that could result in the U.S. government substantially expanding its ownership of the struggling bank, according to people familiar with the situation.

While the discussions could fall apart, the government could wind up holding as much as 40% of Citigroup’s common stock.

Here again, the Fed is already into Citi for $45B.   This little ditty has a twist from the others.   Citi is spinning this saying “it won’t cost the taxpayers a dime!”   Oh lucky us, not exactly.

You see, nearly all accounting and investing rules will tell you that at 40% ownership you effectively control the company.   Once you own the company, you are responsible for it.   Once you’re responsible for it, if the company should need additional capital, you as the major shareholder will be put in the position of either putting up that capital or diluting your ownership.   For an entity that can just run an inkjet to get the additional capital, the answer is easy.

Oh, and the part about not costing the taxpayers anything, not so much.   The preferred stock that we currently have gets periodic interest payments.   It is also in a senior position to common shareholders should the company go bankrupt.   By converting to common stock the interest payments will go away.   Thus, at the very least it will cost the taxpayer something short term and if the company ultimately fails or needs more money, it will definitely cost more.

Finally thought on this one; even though the Obama administration’s spokes person said just 3 days ago:

“This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government”

Don’t “bank that!”   Remember, all Obama positions have expiration dates.

Bringing it all together:

Remember that the automakers are back talking about plans for their future support.   If any of you believe that just one more government infusion will get the automakers back to a point where they’ll be able to function on their own please take note of what’s happening in the financial industry.   When it comes to government “help,” it’s fair to say:

In for a penny, in for a pound!

As is apparent to anyone who has paid any attention lately, the economy is challenged.   The situation is so difficult that the latest forecast  from the Congressional Budget Office (CBO), issued prior to the Stimulus bill, indicates that the deficit for the current year would be nearly $1.2 Trillion.   The CBO’s estimate of the impact Stimulus bill is to increase the deficit by another $185 Billion for a new total $1.4 Trillion.

This weekend in his weekly radio address, President Obama spoke about the need to get the deficit under control.   With a deficit of at least $1.4 Trillion this year, President Obama set out a goal of reducing the deficit to a mere $533 Billion by the end of his first term.    Simply amazing, or maybe not.

According to that same CBO forecast, the projected budget deficit for the last year of Obama’s first term, FY 2013, was projected to be $257 Billion.   Yeah, yeah, I know.   That nasty stimulus bill really jacked the future deficit up right?   According to the CBO’s analysis, the increase is $28 billion in 2013 for a total of $285 Billion.

Well, that’s odd!   Yes, but that’s not all.

In the same CBO forecast, they gave the estimated change to the deficit  for a variety of other actions.

You may remember that Obama has promised to remove troops from Iraq within 16 months?   You may also remember that Obama promised to make Bin Laden “Job #1”.   I think it’s safe to say he’ll have that solved in the same 16 month period and because Bin Laden is the only trouble maker in the region, we should be able to pull the troops out of Afghanistan, certainly by 2013.   The CBO forecast shows an alternative benefit of $30 billion if the total number of troops in Iraq and Afghanistan are reduced to 30,000 by 2013.   He shouldn’t need that many but I suppose a token force is OK.

The CBO forecast assumes that the “Bush tax cuts” are allowed to expire, something that Obama has promised, so you don’t need an adjustment there.

The AMT gets fixed each year so that new folks aren’t pulled into it.   While I doubt Obama will continue this because of his need to trap the few taxpayers left into higher brackets, I’ll be generous and take the $45 Billion, including interest, impact against the deficit.

That leaves us at a projected 2013 deficit of $290 Billion.   That looks to be more than 45% less, $243 billion below, the audacious target President Obama has set for himself.   Huh?   The CBO tells us that discretionary spending, that which Congress can control without changing things like Medicare, Social Security etc., will be $1.220 Trillion in 2013.   For the budget deficit to grow $243 Billion over the latest, adjusted for the Stimulus plan, forecast  by the CBO, Congress will need to increase their discretionary spending by 20% over the assumed increases for inflation, growth and GDP adjustments.   In the CBO’s forecast, discretionary spending is only expected to increase by $36 Billion over Obama’s term.   If discretionary spending does increase by $243 Billion over the rate that the CBO has projected, it will grow at a rate that is 675% higher than that projected rate.  

In November of 2008, while yet simply PEBO, Obama stated:

We will go through our federal budget – page by page, line by line – eliminating those programs we don’t need, and insisting that those we do operate in a sensible cost-effective way.

I guess this is yet another Obama promise that came with an expiration date.

On the plus side, a couple of additional announcements like this and Obama’s planned increase in the capital gains rate won’t be very news worthy.   What capital gains will be left to tax?

You’ve probably heard the adage, “When the US gets a cold, the rest of the world gets pneumonia.”   The adage comes from the fact that world economies intertwined and the US, being the largest, influences a lot of what happens in the rest of the world.   Early in this economic downturn several financial experts attempted to argue that there had been a significant decoupling of world economies.   They argued that while issues were deteriorating in the US, other countries, especially China, wouldn’t see the downturn because their economy was much more stand alone.   While the evidence is obvious that these folks were wrong, Marc Faber does a good job of reconstructing events and deconstructing the decoupling myth, in yesterday’s WSJ.

Admittedly, Faber is known as Dr. Doom.   He has had a perspective on US financial management that is less than complimentary.   That said, Faber’s analysis is still spot on.

Faber’s key descriptive paragraph of the events of this downturn is here:

In 2008, a collapse in all asset prices led to lower U.S. consumption, which caused plunging exports, lower industrial production, and less capital spending in China. This led to a collapse in commodity prices and in the demand for luxury goods and capital goods from Europe and Japan. The virtuous up-cycle turned into a vicious down-cycle with an intensity not witnessed since before World War II.

As important as the tear down of the decoupling theory is Faber’s take on what caused this bubble to burst and what is to be learned from our experience.   As to what was the cause, Faber says:

Sadly, government policy responses — not only in the U.S. — are plainly wrong. It is not that the free market failed. The mistake was constant interventions in the free market by the Fed and the U.S. Treasury that addressed symptoms and postponed problems instead of solving them.

Faber rightly identifies the Fed’s easy credit monetary policies following the Dotcom bust as the fuel for the next bust.   By keeping rates artificially low for too long, Faber argues:

The complete mispricing of money, combined with a cornucopia of financial innovations, led to the housing boom and allowed buyers to purchase homes with no down payments and homeowners to refinance their existing mortgages.

Read the whole article.   Faber is correct in his analysis and he is correct on what he sees from the folks who are attempting to “do something” to resolve this problem:

So what now? Unfortunately, Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner were, as Fed officials, among the chief architects of easy money and are therefore largely responsible for the credit bubble that got us here. Worse, their commitment to meddling in markets has only intensified with the adoption of near-zero interest rates and massive bank bailouts.

Faber’s suggestion for what should be done?

The best policy response would be to do nothing and let the free market correct the excesses brought about by unforgivable policy errors. Further interventions through ill-conceived bailouts and bulging fiscal deficits are bound to prolong the agony and lead to another slump — possibly an inflationary depression with dire social consequences.

All the Fed, Treasury and Congress have done in this downturn is to cause more fear and uncertainty.   They have done nothing to change the arc of the events that they all were a part of creating.   By implementing programs like today’s housing bailout, US financial institutions and businesses will be even less likely to put themselves out to take risk.   After all, who’s to say that tomorrow Congress won’t decide that their business needs to have contracts revoked, rewritten or renegotiated by force.   Until the Fed, Treasury, Congress and President Obama quit making “the rules of the day” don’t expect the US economy to improve or recurrent, wasteful spending to slow down.