Save the US Government

US federal budget deficit jumped to US$4545bn or 3.2% in fiscal year 2008 (US$162billon, 1.2% of GDO in 2007) and this is expected to hit US$1 trillion or nearly 7% of GDP in 2009 – highest in the post War II period, exceeding the 1983 high of 6% respectively.

Deepening recession and falling corporate profits will weaken government revenues and topping with new fiscal stimulus program to be debated by Congress of US$300 billion will drive government’s debt-to-GDP ratio from 37% in 2007 to above 50% - the highest level since 1994.

The Congressional Budget Office (CBO) shows that in the past 6 recessions, the budget deficit widened by an average 1.6% of potential GDP but this time around, I am expecting an outsized impact on deficits. President-elect Obama advocates such a stimulus program, as does Federal Reserve Chairman Bernanke. In the ‘Economic Policy Agenda’ of Obama Nov 5 2008, the amount is expected to be at least US$300bn, or more than 2.2% of GDP, include some of the components of Obama’s economic platform – tax cuts for lower and middle income households, further subsidies for distressed homeowners, job creation program primarily geared towards infrastructure building etc, will occur in FY20098 and some of it are likely to spill into 2010 and later.

The soaring of debt and rising outstanding government debt will definitely lower the potential growth that would occur otherwise and eventually taxes will be increased. Presently, interest rates are low and the yield curve is steep, reflecting low or negative real interest rates associated with recession, but dynamic will be changed, which will eventually push up US bond yields.

The pool of excess global savings will shrink as the booming high savings emerging nations will decelerate markedly. These economies have to redirect a sizeable share of national income toward internal activities, hence significantly reduce the pool of funds available to purchase US dollar-denominated assets. Likewise, with the case of oil producing countries – OPEC and Russia that are succumbing to effects of falling crude oil prices.

In essence, this could be the turning point from a deflationary to inflationary concerns and neither the Fed or the Treasury have had any time to consider an appropriate ‘exit policy; to reverse their recent strategies, in line with rising pressure on interest rate front.