The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally.

For this is the third time in history that a major economy has found itself in a liquidity trap [...]

The first example of policy in a liquidity trap comes from the 1930s. The US economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment.

Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while FDR tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.

The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession.

And here we go again. […]

To sum up: A few months ago the US economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.

Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss.

Although we’re are on the other side of the economic divide from Krugman (we don’t believe the government can borrow and spend its way out of a debt crisis), he makes an interesting point about the difficulty of reversing course once the government puts an entire economy on fiscal and monetary life support.

Now that the feds have become such large players in the economy (backstopping over 80% of GDP and pouring trillions of dollars of liquidity into the system), the next challenge is for them to exit the market without causing another severe leg-down.

Considering the government mucks up everything it gets its fingers on, this “grand exit” should be no different. The feds will either pull liquidity out too fast, pushing the economy into protracted slowdown, or they will fail to reabsorb liquidity fast enough, triggering a great inflation. Here at Notes, our hunch is it will be the latter…

The shortfalls are the result of the significant drop in tax revenue that has stemmed from soaring unemployment and tax cuts.

The Social Security fund represents $2.4 trillion of IOUs from the government, which has borrowed liberally from the program’s surplus to fund other projects. The Social Security surplus has allowed the government to avoid borrowing more than $2 trillion over the past 20 years. But as the gap between Social Security’s intake and its payout narrows, it becomes increasingly likely that the government will have to act.

“When Social Security needs to draw down the ’surplus,’ the Treasury will have to borrow money, raise taxes, or cut other spending in order to redeem the IOUs,” Charles Konigsberg, a federal budget expert at deficit watchdog group the Concord Coalition, told CNNMoney.

The Congressional Budget Office projects that Social Security will collect just $3 billion more in 2010 than it will pay out in benefits. The officials who oversee the program estimate that Social Security payouts will surpass the program’s revenue by 2016. By 2037 the fund will be exhausted, meaning just 76% of the promised benefits will be able to be paid out.

Medicare is even worse off. Whereas Social Security has about seven years before the program’s payout begins to exceed its intake, Medicare is already outspending its tax revenue.

By 2017, the Medicare hospital insurance trust fund will be exhausted, meaning the current level of payroll taxes will only be able to pay 81% of hospital insurance cost.

Lower taxes and higher unemployment have sapped the Medicare fund, but the greater threat continues be rising healthcare costs. Healthcare will consume 17% of the country’s GDP this year, and that figure is expected to be 20% by 2017.

“The only way to slow overall healthcare spending is through comprehensive and carefully crafted legislation,” said Health and Human Services Secretary and Medicare trustee, Kathleen Sebelius. “This report makes it clear. Reform can’t wait.”

According to President Barack Obama and Democrats on Capitol Hill, reform is on the way. The President announced Monday that insurers, hospital executives and drugmakers have agreed to cut $2 trillion from the nation’s healthcare bills over the next decade.

The goal is not to lower healthcare costs from their current level, but to reduce the rate at which those costs are rising by about 1.5 percentage points a year. Healthcare costs are rising at a rate of 6% to 7% a year. If effectively applied over the next 10 yeas, the rise in costs would be 20% below what is currently expected.

Furthermore, Congress will have legislation fixing the nation’s healthcare system before lawmakers take their August recess, the President in conjunction with House Democrats announced yesterday (Wednesday).

“As I’ve said before and all Americans know, our healthcare system is broken,” Obama said. “We’ve got to get it done… and we don’t have any excuses. The stars are aligned.”

Congress is scheduled to take its summer district work period from Aug. 3 to Sept. 4.

Source: Time Running Short for Social Security and Medicare

Whoever said irony died after 9/11 clearly didn’t anticipate this.  “Now that President Obama has signed a $787 stimulus package  into law and weighed tens of billions more to aid homeowners and banks,” deadpans a hastily-written New York Times political blogpost, “he will take a break next Monday to consider just how the government can get a grip on its increasingly ugly balance sheet.”

90 invitees will wring their hands over the prospect of a $2 trillion dollar deficit this year.  No word yet who exactly is on the guest list, but we know the rough makeup of this august panel — 30 House members, 30 senators, and “30 scholars and representatives of advocacy groups such as AARP.”

Well, I guess the irony of inviting habitual big spenders isn’t too thick if George W. Bush isn’t among the invitees.

“After Mr. Obama opens the summit,” the Times continues, “the assemblage will break into six groups. Each will discuss separate topics that encompass the range of fiscal challenges that would exist even without the current recession and will endure once the economy recovers. The topics include health-care costs, Social Security, tax reform, defense procurement and the federal budget process.”

I can give you a rough outline of what these guys are going to come up with right now, before the summit takes place, without even knowing who’s taking part.

• Health care costs: No big solutions will be proposed, but whatever short-term fixes are floated will will further intrude on privacy, further restrict patient choice, and further line the pockets of the insurance companies.  (Memo to everyone who fears “socialized medicine”: Never gonna happen.  What will happen is a further cementing of a system that, if I may borrow from James Grant’s terminology for the financial sector, privatizes profit and socializes cost.  Free-market fee-for-service solutions?  That’s not something Serious People talk about.)
• Social Security: Again, don’t expect any big pronouncements here, but we will get some sort of trial balloon for raising taxes and/or lowering benefits.  The president’s budget chief is on record supporting benefit cuts for everyone under age 55.
• Tax reform: Oh, let me guess.  Maybe a recommendation to fix the alternative minimum tax once and for all.  And said proposal will go nowhere.  Fundamental rethinking of the system will not be open for discussion.
• Defense procurement: Much noise about reining in costs, maybe even lip service to rethinking whether we need Cold War-era ships and aircraft to fight guys in caves.  But as with the health insurance industry, the special interests are simply too well-entrenched.
• The federal budget process: Lip service to fighting “waste, fraud, and abuse.”

There, that was easy.  There’s your “fiscal responsibility summit.”  Everyone can slap each other on the back when it’s over and feel really good about themselves when they go home.  And we’ll fall even further into a multi-trillion-dollar hole.

Source: Fiscal Responsibility Follies

Even more horrifically, I have seen other people calculating that the budget deficit will range upwards to $2 trillion, and maybe more. Maybe much more!

I say this because I thought I had become a hardened veteran of the government and the Federal Reserve acting like morons, and I had bravely resigned myself to the collapse that such idiocy deserved. As a result, I had a swagger in my step and a sneer in my voice to prove it, but now, this prospect of a multi-trillion dollar budget deficit caused me to have a little “accident” in my pants at the news that the federal budget, which was already scheduled to be $3 trillion before any of this stuff happened, is now going to have a deficit of trillions of dollars, all in an economy that is only about $13 trillion! Gaaaahhhh! I am freaking out here!

I keep thinking to myself that this is so Freaking Much Money (FMM) that it would only cost $2 trillion to give $10,000 in cash to every one of the 200 million adults in the whole damned country! Gaaahhhhh!

I seem to remember, and police reports confirm, that this horrific news sent me screaming into the night, shouting not only, “Gaaaahhhh!” but also, “We’re freaking doomed, you morons! Buy gold and protect yourselves from Mother Nature’s Backlash (MNB) against your constantly acting stupid by electing spendthrift, promise-them-everything morons to government office, who have allowed the Federal Reserve to create so much money and credit to accommodate government deficit-spending that that government has now spent you into debtor’s hell to support a government So Freaking Huge (SFH) that the total of government spending constitutes half – half! – of all spending in the freaking country! Half!”

Somewhere around 52nd Avenue I am heard saying, “And you have spent yourself to a debtor’s hell as well, you morons, by buying your own debt to fund your own stupid retirement plans, which is akin to trying to make money by eating one’s own, ummm, poop, you morons!!”

Fortunately, I calmed down before the police could actually arrive and catch me in the act of disturbing the peace or actually making threats against my neighbor who is so stupid that he will not buy gold, no matter what I do, or even shut up long enough to listen to me when I am trying to politely explain to him what a moron he is for not doing as I tell him.

And the reason that I calmed down was because I suddenly thought to myself, “Whoa! I sure as hell could use $10,000 for myself, and a nice $20,000 for being married; filing jointly for a wad of lovely, lovely cash would be lovely, too!”

And then, as another benefit of giving money to people, I thought of older people who’ve had their damned grown children move “back home” to live with them, all crammed into the one house, sometimes dragging their kids along; but if you kick them out to live in their stupid car like they deserve, even offering to let them use the garden hose outback to clean up, everybody yells at me and calls me names, like I did something wrong!

But with a $20,000 windfall between them, you would feel vindicated, and indeed righteous, to kick them the hell out of your house! “Get lost, parasites!” Hahahaha! Sweet!

But apparently the “shocking” quality of this $1.186 trillion budget deficit has given the CBO a sudden clairvoyance, because they figure that the budget deficit will, somehow (they don’t explain how, or why), “decline to $703 billion in FY10″, which I mention only because I thought I could turn it into some scathing sarcasm of some kind before I lost interest in it, but, then again, a $703 billion budget deficit is still nothing to sneeze at!

Even so, the article goes on, “The CBO report almost certainly understates the severity of the nation’s fiscal woes”, because. “For example, the CBO report does not account for the emerging fiscal stimulus bill that may cost more than $800 billion over two years” which brings us up to a budget deficit of $1.98 trillion!

And while you are gasping for breath at the horror of it all, it certainly does not even take into account the inevitable hundreds of billions of dollars in “supplemental appropriations” that Congress routinely authorizes all year, every year, and which in the last 12 months amounted to more than an incredible $1.4 trillion dollars of additional public debt, and which now stands at the unbelievable sum of $10.635 trillion, in an economy that is only $13 trillion, where now these weenies are proposing to borrow and spend another $2 trillion freaking dollars! Gaaahhh! We are so freaking doomed!

Those who are paranoid enough, smart enough or lucky enough to be sitting on piles of gold, silver and oil are no doubt sitting cool right about now, while those who are not similarly paranoid enough or well-stocked with gold, silver and oil must be going freaking nuts and their hearts are hammering boom, boom, boom as they watch their own destruction approaching.

And as a guy who has some of all three, I say, “Whee! This investing stuff is easy!”

Source: A World of Financial Freeloaders

Unless the cynical premise of Rush Limbaugh’s “Operation Chaos” is realized, and the Democrat presidential wingding continues to move forward at an increasingly vitriolic level through that party’s national convention in Denver in late August, whomever wins the Democratic nomination is pretty likely to be our next President. So, as investors – whether Democrat or Republican – which of the two candidates should we be rooting for?

The Case for Clinton

Our initial reaction would probably be that this question looks like a no-brainer. The Standard & Poor’s 500 Index rose from 427 to 1,342 during the eight-year administration of Hillary Clinton’s husband, giving investors an average annual total return of 17.4% – the highest of any presidency since World War II.

That huge market run-up – and the hefty yearly returns – were pretty much justified. President Bill Clinton was committed to a balanced federal budget, raised taxes only once, and that in a moderate fashion, reformed welfare and signed the North American Free Trade Agreement (NAFTA).

All of those policies were immensely beneficial to the U.S. economy – and to investors – as, in the short term, were the monetary expansion policies of the Alan Greenspan-led U.S. Federal Reserve (although we may well be paying the long-term price for that now). If we could be sure that Clinton would follow her husband’s policies, and that the economy was in a state fairly similar to that of 1993, we could as investors be confident that a Hillary Clinton presidency would contribute significantly to our collective net worth and, on balance, would serve the entire country equally as well.

When it comes to taxation, Sen. Clinton wants to reverse the George Bush tax cuts, and favors increases in the Social Security tax for those at the top of the income scale. She also favors a higher capital gains tax – all measures that tend to reduce both economic growth and investor returns. She also favors windfall taxes on oil companies, and has a healthcare plan that would be very expensive and that must be paid for somehow.

Perhaps the biggest difference between the two Clinton’s is Hillary Clinton’s economic populism. When Bill Clinton ran for president in 1992, he campaigned on the catchy platform, “It’s the economy, stupid.” But he was notably free of the economic redistributionist and corporation bashing that had weakened the credibility of such presidential campaigns as Walter Mondale’s in 1984 and Mike Dukakis’s in 1988. When Bill Clinton was president, his treasury secretaries – Lloyd Bentsen, Robert Rubin and Lawrence Summers were notably centrist and business-friendly. Economic populism only returned to the Democratic mainstream with the Al Gore campaign of 2000, and that may well be why he narrowly and unexpectedly lost to current President George W. Bush.

Sen. Clinton, on the other hand, already has proposed an economically nonsensical but populist idea – a gasoline-tax “holiday” for the peak summer driving season between Memorial Day and Labor Day, to be paid for from the profits of big oil companies. Such a tax change would tend to increase oil consumption, driving up prices, worsening any global warming and benefiting largely the mega-wealthy oil states of the Middle East and Venezuela.

The Sen. John McCain version of this proposal, without the attack on the oil companies, would be a subsidy from U.S. taxpayers to the oil sheiks; the Clinton version is a subsidy from the U.S. oil majors to the oil sheiks. Neither version makes much economic sense.

Obamanomics

Obama shares the Hillary Clinton flaw (from an investor viewpoint) of wanting to increase taxes – including capital gains taxes – at the top end of the scale. However, his healthcare plan would be somewhat cheaper (because it would mandate coverage only for children, not for everybody). And he’s more dovish on the Middle East, which may or may not be good policy, but is certainly likely to save money. On trade, Obama has echoed Clinton in protectionist Pennsylvania, but is believed to be generally more trade-friendly. He has notably failed to endorse the gasoline tax cut, describing it as a “classic Washington gimmick.”

When it comes to policy, then, Obama beats Clinton in investor-friendliness, albeit not by very much.

However, the really difficult question to consider is the current state of the U.S. economy.

In 1993, the U.S. economy was emerging from a recession, with only the federal budget deficit as a major worry. On the positive side of the ledger, there were signs that the economic reforms of the 1980s had made the United States more competitive with the rest of the world. In that situation, government mostly needed to get out of the way and allow the boom to billow, and that’s essentially what President Bill Clinton did.

The 2008 version of the U.S. economy is much less clear. Indeed, the outlook is downright cloudy. Commodity and energy prices are at record levels and are likely to produce substantial consumer price inflation in the months ahead. Interest rates already are at exceptionally low levels – more than two percentage points below the rate of inflation – in order to cope with the U.S. economy’s continued financial crisis.

Housing is in a deep recession, with prices dropping more rapidly than at any time since the early 1930s. The dollar is weaker against other currencies than it has ever been, yet the United States still has a huge balance of payments deficit, suggesting it is less competitive than it should be. Stock prices, which in 1993 were at moderate levels, are today within 10% of their record highs, yet corporate earnings are declining, led largely by the disappearance of earnings from the financial sector.