My Two Cents - "Behind the Curve"

1/19/2007

While perusing the business news of the day I ran across an article in which Fed Chairman Ben S. Bernanke testified to Congress that he sees peril in the fact that the government continues to run large budget deficits. He said that without 'early and meaningful action' the deficit situation could easily spiral out of control.

"Who are you and what have you done with Ben Bernanke?"

Contrarians from all circles have been arguing exactly these points for some time now, with the majority of those arguments falling on deaf ears as the financial press was too busy learning new cheers for the next stock market bubble. We have been told for years now that deficits are nothing more than an indication of our strong, growing economy and, like money supply, shouldn't be counted too heavily in the overall analysis.

This is out of character for Bernanke to say the least. A typical speech for the helicopter commander recently is to say that there are still inflation fears even while the gerry-rigged CPI and PPI were coming down and to assuage those fears by pointing to a moderation in growth as a catalyst for lower inflation. This scenario has been dubbed the goldilocks economy by many contrarians. Suddenly, Ben seems more concerned with a giant bear, in the form of the budget deficit, ready to run Goldilocks out of town.

"Economic growth alone is unlikely to solve the nation's impending fiscal problems."

Bernanke testified that if taxes are to be kept constant then spending must follow as well, and that any additions to programs must be viewed in terms of the tax ramifications. Nowhere does he mention his secret weapon - the printing press. The Fed has been inflating all of 2006, now at a 5.1% y/y rate - still well above the growth of GDP even in nominal terms. If you consider theoretical M3, that number is closer to a 10% growth in aggregate money and credit y/y.

In short, Bernanke's comments left me scratching my head as I wonder where all this is going. Today's comments were so out of line with recent Fedspeak, yet at the same time so far behind the curve. How could he lament over the budget deficit without mentioning its evil twin the trade deficit now over $700 Billion per year? There are a couple of possibilities for this:

1) He sees the trade deficit as more of a monetary phenomenon than a structural defect in the economy.

Long-term persistent inflation can mitigate much of the real worth of the trade deficit. In other words, the debt can be made worthless over time by inflationary policies. If the ultimate endgame is inflation, then the trade deficit really isn't our problem; just don't tell the Asians.

2) The groundwork for higher taxes is being laid.

The government has to be careful with taxes though. The saturation point for most families has already long been reached. Further tax increases are not going to resonate with families that now have to resort to taking on debt in order to survive. The issue of taxes is a complex one and another entire column in and of itself, but the possibility needs to be mentioned.

3) The comments are designed to open viable discussion on cutting Social Security benefits.

It is fairly common knowledge that there is no 'Trust Fund' for Social Security. That money was pilfered long ago and even worse, the government sees no problem with it. In my opinion, the government also doesn't feel that anyone is entitled to Social Security beyond paying the applicable levy. Bernanke's testimony may be nothing more than a segue into discussions on cutting benefits to avoid a financial crisis. Where that leaves the average person is anyone's guess, but I'll pass along some advice that I've been giving for some time now: Don't count on Social Security or any pension for that matter. If you get it, that's great and it is a bonus, but have savings to whatever extent possible to get you through. I realize that in many cases this is much easier said than done.

Given my own predilections to assume the worst, I would put my pound of salt on either choice #1 or #3. The government has long been paying for new social programs (such as the Medicare prescription drug plan) with inflation and debt as opposed to taxes. Inflation and debt are much more politically favorable as they are silent killers of wealth whereas taxes are more overt so I don't think this is going to launch into a push for tax increases. Keep in mind that I will be poised with a bottle of Heinz 57 to douse my helping of crow if I'm wrong on this one.

Bernanke's comments also could have arisen from nothing more than genuine concerns about the future. Taking today's comments in the context of other testimony and more importantly his actions, I find this to be the most remote possibility of all. On a lighter note, given the amount of news and brouhaha we've seen so far, I doubt that 2007 will disappoint in terms of being a busy year. It would indeed seem that we are under the ancient Chinese curse: "May you live in interesting times".

The Author holds an MBA in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics.

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