Weekly Wrap

Sounding like he really means it, President Barack Obama promised earlier this week to rein in spending by the federal government. His proposed three-year budget freeze, however, does not apply to military intervention overseas, to homeland security, to entitlements, nor to economic-stimulus-that-may-be-needed-from-time-to-time. That leaves only one-sixth of the budget to be "frozen." For everything else, the sky's the limit.

Déjà vu all over again, as Yogi would say. This freeze in "discretionary" spending is exactly what Obama's predecessor, George W. Bush, proposed two years ago when rolling out the nation's first $3 trillion budget. And how well did that work? Glad you asked. The FY2009 budget started ballooning before the ink was dry when Bush okayed the TARP bailout. With the banks taken care of, Obama allocated unspent TARP money to the auto industry. Then came the $787 billion stimulus package. When the fiscal year came mercifully to a close last September 30, federal spending for the year finished just shy of $4 trillion.

Trouble was, $1.8 trillion of that had to be borrowed. $383 billion of it was interest paid on money already borrowed. Obama's "freeze" will not stop the red ink. His FY2011 budget calls for spending $3.6 trillion, or 16% more than the last time a U.S. President used the word "freeze." Can you imagine what a thaw would look like? Congress already has. Yesterday the Senate voted to raise the nation's debt limit by $1.9 trillion to $14.3 trillion. Plus ça change. Now if only the French had a word for entrepreneur.

Add public and private debt together, and you get a number approaching $50 trillion, or almost four times GDP, a record in the U.S.:

courtesy Van Hoisington and Lacy Hunt

The graph illustrates that the debt-to-GDP ratio last saw a similar peak in midst of the Great Depression. It also suggests that much of peak debt needs to be extinguished before sustained economic growth can resume. As Van Hoisington and Dr. Lacy Hunt explain, "once debt becomes excessive, countries do not grow their way out of the problem; they must go through the time consuming and often painful processes of debt repayment and increased saving."

But growing our way out of the problem is exactly what the Obama Administration is trying to do--with fiscal stimulus and near-zero interest rates. The goal: creating more debt in an economy already swamped by debt. Over-exposed consumers are doing the right thing by paying down credit balances, but lenders are too slow to write off bad debt, some of which has simply been transferred to the Federal Reserve Bank's balance sheet through the creation of new fiat currency. American exceptionalists, take note. A recent book written by Carmen Reinhart and Kenneth Rogoff entitled This Time Is Different concludes, after abundant historical research, that no time is ever different: debt deflations are always painful and protracted.

Just in from the Commerce Department: GDP grew at an annual rate of 5.7% in the fourth quarter of 2009. Before jumping to the conclusion that we can grow out of this mess, look more closely. Most of the statistical increase was due to the restocking of depleted inventories; final sales were up a more modest 2.2%. Personal consumption was up just 1.4%. Hours worked in the private sector were down 0.5%. David Rosenberg of Gluskin Sheff calls it the Houdini recovery, destined to disappear once inventory builds and capital spending have run their course. Bottom line, today's headline GDP is a rear-view, drug-induced number unlikely to be repeated anytime in 2010.