Budget Deficits Are Back in Fashion

The world is going back in time. Pirates roam the seas and take oil tankers hostage. A 500-year old penguin thought to be extinct is rediscovered in New Zealand. General Motor’s share price falls to levels not seen since 1942. And governments around the world (those that aren’t already bankrupt) prepare to assume command of their economies.

But where will they take them? The future is a place you arrive at whether you like it or not. All you really have control over is how prepared you are to engage with it. These days, however, there’s a lot of nostalgia for the past, namely, how did we get out of the last big global economic catastrophe in the 1930s. More on that shortly.

First, the share markets are punishing the lumbering dinosaurs of the American economy. GM fell 18% in New York trading. Ford was down 24%. Citibank fell 17% to a 13-year low. The Dow closed under 8,000 while the Nasdaq fell over 6.5%. There are now serious doubts about whether GM and Citigroup will survive without major government intervention.

Even then, it’s going to be touch and go. But investors seem to have rendered their verdict this week. It also looks like U.S. stocks will re-test the 2003 lows shortly. Where they go if they break through on the downside is anyone’s guess.

The CEOs of the Big Three automakers flew by private plane to Washington to ask for a piece of the TARP. “Without immediate bridge financing support, Chrysler’s liquidity could fall below the level necessary to sustain operations in the ordinary course,” said Chrysler CEO Robert Nardelli. GM’s Rick Wagoner said that if Congress allows the automakers to go under, “the societal costs would be catastrophic.”

But Treasury Secretary Henry Paulson fronted Congress earlier the week and seemed less than willing to redirect TARP money away from Wall Street and to Detroit. “I don’t see this [an automaker bailout] as the purpose of the TARP…Congress passed legislation that dealt with the financial system’s stability.”

But back to the issue of ‘societal costs.’ We would argue that we are just now finally beginning to pay the societal costs of a sustained economic policy that favoured finance and consumption over production and savings. That policy saw the formation of a Wall Street-Treasury Department Axis.

That Axis advocated running a capital account surplus. It was partly to offset the rising current account deficit. But in some ways, the surplus in the capital account came about because of policies that encouraged debt and consumption, the very things that led to the current account deficit. The result was a boom in American financial services-while American manufacturing was shipped offshore.

The costs of THAT policy are not going to be absorbed by TARP or any other bailout planned by Congress. The costs, by the way, are higher unemployment, fewer skilled workers, greater consumer debt, more government borrowing from foreign creditors, and the disappearance of a healthy industrial base. Maybe that’s why the Chinese are actually talking about buying GM now.

Maybe they should put Holden on their list too. How can Australia’s car industry survive if America’s can’t? Which do you think is more likely to happen: the government sells key parts of the industry to foreign buyers, or the government nationalises the industry via deficit spending?

Reserve Bank President Glenn Stevens gave a speech yesterday in which he gave the government the economic cover it needs to run a deficit. He said, “If governments are able to so order their affairs as to continue supporting worthwhile – and I emphasise worthwhile – public investment (even if that involves some prudent borrowing), then Australia will come through the present period.”

Of course Australia will “come through it.” But in what kind of shape? We wish we had seen all this coming and warned more accurately ahead of time. But now that what we’re here, what is to be done? Part of the task is to figure out how bad it will be for Australia.

It will probably be worse than most of the media currently believes. If housing starts in the States are at an all time low, if China is reducing demand for coal and iron ore, and if all three of the world’s largest economies are in recession, do Australian policy makers really believe they’re going to sail through the crisis with no major collateral damage in the property market or in the employment figures?

If the RBA and the Rudd government begin reading from the global Keynesian playbook, you should be prepared for a huge deficit. We heard an economist on television a few weeks ago that the Government ought to run a $50 billion deficit as it amps up spending to combat the global slow-down. That’s about 5% of Aussie GDP.

Europe is considering a stimulus package of 130 billion Euros (A$255 billion). In the U.S., there’s no telling where the stimulating will end (although we continue to believe the government will eventually bypass the banks and issue debit/stimulus/ration cards directly to Americans.

“Iran blocks access to over five million websites,” reports the AFP. Substitute “Australia” for “Iran” and you have a pretty good idea of what your browsing future looks like under Communications Minister (Ayatollah) Stephen Conroy’s plan. The era of command and control advances.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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