President Obama made history yesterday. On July 13, 2009, President Barack H. Obama became the first president of the United States to preside over a federal budget deficit of $1 trillion.
According to the Treasury Department, the deficit for the current fiscal year, which started in October 2008, reached a total of $1.09 trillion by the end of June (citation). The rising deficit was due to both increased government spending, such as this year’s stimulus package, as well as falling tax revenues due to business difficulties and rising unemployment.
According to the Obama Administration’s own projections, the deficit will continue to rise. The administration’s forecast is that the deficit will reach $1.84 trillion by the time the fiscal year ends in October. The passage of additional costly programs, such as national health care plan or a second stimulus plan, would drive the deficit even higher.
The federal debt is now equal to 80% of the US gross domestic product (GDP), the annual output of the US economy. Federal debt levels have not been this high since WWII when they reached 120% of GDP as we fought for survival against Japan and Nazi Germany.
Disturbingly, Obama has not revealed any plans for actually repaying the borrowed money that he is spending. His projections show the federal government running trillion dollar deficits well after he leaves office and into the next decade.
Most observers believe that there are only two possible ways to repay such staggering deficits. One way is to raise taxes. The problem is that the debt is so mind-blowingly large that to raise taxes enough to pay it would cripple the economy.
A second possible course of action is to devalue the dollar. If the government simply prints more money, it will have the money to pay the debt but, at the same time, the money (and the debt) will be worth less in real terms. This will lead to inflation, in which everyone’s money is worth less and won’t buy as much. This also leads to economic problems such as the stagnant growth and high unemployment seen in the 1970s.
A third course of action is that Obama may not believe that action on the deficit is necessary at all. His economic plan hinges on the belief that government spending will produce economic growth. This view has not been supported by reality since unemployment has risen to almost 10% since the passage of the stimulus bill.
Criticism of past government relief plans such as FDR’s New Deal and the Japanese recovery attempts of the 1990s has been that the governments involved did not keep spending long enough. This theory holds that the government should keep spending to maintain the (illusion of) economic recovery. There seems to be no consensus on when, or if, the government can phase out its spending programs.
If Obama holds this view, it is likely that he will make no serious effort to reduce spending. In this case, the government is likely to keep running deficits that are greater and greater until investors who buy US government debt and securities become concerned enough with the risk of their investment to put their money elsewhere.
If countries such as China stop buying our debt, the US might find itself insolvent overnight in much the same way that banks such as Bear Stearns found themselves bankrupt last year. For the United States, however, there will be no bailout package.