$2,000,000,000,000. That’s the amount by which the Obama administration raised its ten-year estimate of the nation’s budget deficit from the one it made only a few months ago. Now, $2 trillion is a lot of money. But even more significant is the fact that this revision represents almost a 30 percent increase — no tiny percentage of the earlier $7 trillion figure. It seems that expenses are higher — up 24 percent this year, the largest increase since the height of the Korean War — than originally estimated, and revenues are lower. The resulting deficit, says Peter Orszag, Obama’s budget director, is “higher than desirable”. He might have added that the administration’s critics had it right when they claimed that the earlier estimate represented a turn around the dance floor with that old seductress, Rosy Scenario.
There’s worse: the new estimate assumes that Medicare and Medicaid spending will be cut by $622 billion, even though Congress has made it know that it is reluctant to make any such cut. Then there is the $600 billion in revenue included for the sale of emission permits, despite the fact that the House has given away so many permits in order to buy support for the cap-and-trade emission-reduction that the program will produce at most $450 billion. Those two items alone come to almost another trillion dollars in red ink. Throw in another trillion-plus for Obamacare, and it is no surprise that senior economist Bill Gale, at the liberal Brookings Institute, says that the deficit will hit over $10 trillion over the next decade, a figure he finds “deeply alarming”.
This year, the deficit will come to 11.2 percent of GDP, and by 2019 the debt will be equal to 76 percent of the value of the nation’s output of goods and services, almost double the 41 percent when Obama took control of the nation’s finances. No problem, say White House economists. Unsustainable, says Warren Buffett, among others.
Which brings us to Martha’s Vineyard and Beijing. A tie-less President took time off his vacation on Martha’s Vineyard to praise and reappoint an also tie-less Ben Bernanke to another four-year term as chairman of the Federal Reserve Board. The lack of neckwear could not conceal a certain tension. The president was trying to divert attention from the very bad news about his burgeoning budget deficits, and the chairman was trying to reassure the markets that notwithstanding his reputation as “Helicopter Ben”, the man who would fight recessions by dropping cash from the skies, he would indeed rein in all that extra liquidity when the right time comes. Given that his new term runs until the end of January, 2014, Bernanke can with impunity tighten just as Obama launches his 2011 campaign for a second term. Recall that it was just such a tightening and consequent slowing of the economy by Alan Greenspan that George Bush the elder still feels handed the 1992 election to Bill Clinton. For good central bankers, gratitude at reappointment does not trump sound policy.
So the marriage of convenience between Democrat Obama and Republican Bernanke might not end on a pleasant note. Especially if the chairman decides sooner rather than later that the era of quantitative easing — jargon for printing money — must come to end lest the dollar begin to take on the characteristics of the now-deceased (but remembered with fondness in Italy) lira.
Data released since Bernanke’s relatively cheerful talk to his central bank colleagues in Jackson Hole, Wyoming, support his view that the worst is probably over. Earlier this week the Commerce Department announced that sales of new homes rose by 9.6 percent in July after an increase of 9.1 percent in June. Sales are still running 13.4 percent below July 2008, but are up 32 percent from the January record low, bringing the inventory overhang down to 7.5 months’ supply.
The news from the market for all homes, existing as well as new, was even cheerier, especially since it is based on a larger number of sales and is less subject to revision. The much-watched Case-Shiller Index of house prices in twenty metropolitan areas recorded an increase of 2.9 percent during the second quarter. Prices remain 14.9 percent below the second quarter of last year, but rose in eighteen of the twenty areas covered by the Index. This latter performance prompted Karl Case — the Case of Case-Shiller — to exclaim, “When I saw these numbers, I danced a jig. It appears that the housing market is stabilizing quicker than people thought it would.”
The sales strength, which surprised many observers, was due in part to relatively low interest rates, in part to a rise in consumer confidence — up to 54.1 in August from 47.4 in July, and 25.3 in February according to the Conference Board (90 is considered sign of a healthy economy, 100 of a growing one) — and in part to an $8,000 tax credit for first-time home buyers. That credit is due to expire on November 30th, and some observers worry that home sales might drop sharply since anticipation of the end of the credit program might be stimulating buyers to buy now rather than later, just as the just-expired cash-for-clunkers program ($3,500-$4,500 government rebate to anyone trading a fuel-inefficient car or truck for a more efficient vehicle) brought forward auto purchases that would otherwise have been made later this year. Sales of long-lived durable goods also rose in July, by 4.9 percent, more than forecasters expected but still 25.8 percent below year-ago levels. The pace of manufacturing is also picking up. The Index of Leading Economic Indicators, the Philadelphia Fed Survey, and the Empire Manufacturing Index (New York State) all report gains, leading Goldman Sachs to conclude “that manufacturing is in the early stages of a rebound to correct undue liquidation of inventories.”
On to Beijing, on which Bernanke is keeping a wary eye. From the vantage point of a holder of $776 billion in US IOUs (after selling $25 billion in June), the Chinese see the combination of these signs of an emerging recovery, along with huge deficits that extend as far ahead as the eye can see, and worry that the dollar is certain to deteriorate in value. They want Bernanke to follow the lead of his doctoral supervisor at Princeton, Stanley Fischer, now governor of the Bank of Israel (BoI), and begin to raise rates to head off inflation. Israel is, of course, a tiny player in the world economy, but, as James Lord, an economist with London-based Capital Economics puts it, the response of its central bank to the financial crisis “has been sophisticated [and] Bernanke’s preferred method for reversing any inflationary impact is essentially what the BoI has done “.
Bernanke hopes that Beijing has enough faith that he has a viable exit strategy to continue buying huge amounts of U.S. Treasury securities, as he is not confident enough in the durability of the recovery to raise rates just yet. Retail sales remain weak, loans based on commercial property look increasingly toxic, about one-third of U.S. banks tightened credit standards in recent months, failures of regional banks are on the rise and the list of problem banks is at a 15-year high, and board rooms are not chock full of members eager to approve major investment projects.
When he thinks the time is right, Bernanke will make his move. He wants to go down in history as the Fed chairman who whipped a recession without triggering inflation. He is half way there.
Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).
