Record Budget Deficit, Second Stimulus Package, Our Letter to Congress, and More!

by Addison Wiggin & Ian Mathias

  • Government, envious of stocks, sets a record of its own… the latest incredible budget data
  • Because the first one worked so well: House Democrats push for second stimulus package
  • Byron King on why “it’s too early to break out the champagne” for U.S. equities
  • Bill Gross, Paul Volcker forecast what’s next for the U.S. economy
  • The 5 writes our congressmen… the first official response, below

  The U.S. government announced its biggest annual budget deficit ever this week: $454 billion.

The Bush administration capped off its final fiscal year (ended Sept. 30) with a bang, beating its own 2004 record by $40 billion. Say what you want about G.W., but this much is now officially true: He will go down as the most expensive president in history, and that’s putting it nicely.

Hmmmn… guess we’re not going to balance that thing by 2012 after all…

“This year’s budget results reflect the ongoing housing correction and the manifestation of that in strained capital markets and slower growth," suggested Treasury Secretary Henry Paulson, as if the housing market could have gone up indefinitely and the federal budget would otherwise be balanced by now.

The Bush administration currently forecasts a $482 billion imbalance for the current fiscal year, the majority of which will be passed onto the next president. That projection, however, has yet to be adjusted for the $810 billion “bailout” bill Congress passed earlier this month, most of which will be spent next year.

  On Capitol Hill, House Speaker Nancy Pelosi is championing ANOTHER economic stimulus package. Apparently unconvinced of the first round’s impotency, the Democratic Congress is pushing a $150 billion “economic recovery plan.” No doubt this one will do the trick.

According to Pelosi, this rendition is even more focused on “helping the middle class” and “rebuilding America,” and is supposedly comprised of infrastructure spending, food stamp increases, an extension of unemployment benefits, state government handouts and another round of tax rebates. The prevailing wisdom appears to go something like this: If we take money from those who have it… give it to those who don’t… and borrow the difference from China… our economy will recover.

Hard to beat that logic, isn’t it? We can’t wait to vote.

  “It’s too early to break out the champagne,” warned Byron King yesterday following Monday’s record gains in most of the world’s stock markets. “The economy still has serious problems. The banking system is still broken. Indeed, the whole modern system of investment banking is a smoldering ruin. Something else is evolving to take its place, including a lot of overt state intervention, ownership and control. Yes, government is promising to fix things. It’s like the old saying: ‘I’m from the government and I’m here to help.’

“You can believe what you want about the government fix. Maybe it’ll work. After all, the government did such a great job running the railroads during World War I. OK, I’m just kidding about the railroad thing. It’s a joke. In three short years, the federal government under Woodrow Wilson mucked up the railroads for a generation, if my reading of history is accurate.

“What you need now is safety,” he told his Outstanding Investments readers. “Safety” in Byron’s world is a major oil company currently paying a historically high dividend, better than any money market savings account, plus the potential upside of owning an industry-leading biz. Sounds about right to us… get the ticker by subscribing to OI, here.

  If you stashed your last $250,000 in a coffee can(s) under your bed over the last few months, the government wants you to know it’s now safe to give it back to your favorite bank. The FDIC announced today it has upped its depository guarantee from $100,000 to $250,000. The move, we’re told, will boost depositor confidence and restore trust between “Joe Six-pack” and Wall Street.

  The U.S. stock market started off with another massive gain yesterday, but dwindled to a small loss. The Dow shot up 400 points, about 4.2%, out of the gate, but ultimately registered a loss of 0.8%. The S&P 500 fared a bit better, down 0.5%.

The Nasdaq got hit hardest yesterday, down 3.2%. Google was downgraded by Barclays. Steve Jobs failed to deliver at his latest Apple love fest. And Intel issued a tepid earnings outlook. Sigh.

  "I have been around for a while,” noted former Fed Chairman Paul Volcker yesterday. “I have seen a lot of crises, but I have never seen anything quite like this one. This crisis is an exception. I don’t think we can escape damage to the real economy. I think we almost inevitably face a considerable recession."

Volker said that while the latest government resources and bailouts have been “really distasteful,” they were “necessary in this emergency to restore some sense of stability and confidence."

  “Because prices are going down in every asset class,” writes bond legend Bill Gross, “the threat to future investment in long-term capital projects and the real economy becomes magnified. That doesn’t mean, of course, that capitalist investors must be guaranteed a profit. Far from it. But when prices in all asset categories decline by double digits, well, then, Washington, London, Frankfurt, Tokyo and Beijing — we have a problem.

So if the government were interested in restarting a bull market in assets of all kinds, how would it?

“A systemic deleveraging likely requires a systemic solution, which moves beyond cyclical interest rate cuts, liquidity provisions or even the purchase of subprime mortgage-backed bonds. We believe that the Federal Reserve must now act as a clearinghouse, guaranteeing that institutional transactions clear… They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past…

“The benevolent fist of government will now join hands with Adam Smith in a most visible manner. Because it will, expect a lengthy recession, but not depression; accelerating government deficits approaching a trillion dollars, as I forecast several months ago; and the eventual rise of inflation and longer-dated bond yields. For now, however, it is best to focus on the potential unfreezing of commercial paper and a globally coordinated policy rate cut. Own the front ends of Treasury/Libor yield curves. Agency mortgage-backed securities will also benefit from Treasury buybacks. Stay liquid, remain in high quality.”

  Bill Gross’ biz, Pimco, was just tapped by the government to serve as asset managers for the Fed’s new Commercial Paper Funding Facility.

Ah. Now his comments make sense.

  The threat of short-term inflation hasn’t disappeared entirely. While the headline producer price index (PPI) dropped 0.4% in September, the Fed’s core measure — stripped of food and energy prices — jumped 0.4%.

Now at 4% even, the core rate is at its highest since 1991. And despite two months of declines for the headline number, PPI still rests at a lofty 8.7% annual rate.

  The Commerce Dept. also reported retail sales declined 1.2% in September — the worst retail number in three years. Auto and auto parts sales led the way, falling 3.8% in the month.

  Commensurately, sales at sit-down restaurants fell 1.8% in the eight months ending in August. Already this year, Bennigan’s and Steak and Ale have filed Chapter 7. Should we continue down the road to recession-ville, you can expect more to follow suit.

  The U.S. dollar, and its erstwhile alter ego gold, have kept to a pretty tight range this week. The dollar index is stuck around 81.3, while gold has been putzing around at $840.

  Oil dropped another $4 today, to $75 a barrel. OPEC cut its 2009 demand forecast again today, by another 450,000 barrels a day. U.S. inventory figures tomorrow could push crude even lower. With oil already at its lowest level since September 2007, look for OPEC to cut production when they meet next, on Nov. 18.

  “Those who predict high inflation,” writes a reader, “because of the government equity infusion into banks are overlooking how much deleveraging remains and how much of the supposed liquidity will vanish into paper losses. In the worst-case scenario, the capital infusions would simply replace reserve requirements destroyed by the unraveling of the debt pyramid. Little of the money would actually go into circulation in this worst case.

“In actuality, some increased credit will occur (not all of the bailout dollars going into reserves). However, it may well be that the amount of increase in money in circulation will be only a fraction of the equity infusion and not provide much inflationary stimulus. Deflation may hold sway for the next couple of years.”

  “One of the readers mentioned yesterday the disparity between physical gold and paper gold,” writes the last reader. “Or as you characterized it, retail versus trader (speculator) prices. It looks to me like the paper gold is DISCOUNTED compared with real physical gold. Paper promises to give you gold are a lot cheaper then physically deliverable gold.

“What does that mean? As long as the traders can keep finding the bigger fool to take the paper, they can keep trading it. Someone will someday be left holding the bag. The discount may be looked at as the risk of paper default. Or to explain it from the other side — physical REAL GOLD (touch-me, feel-me, take-me-home gold) has a PREMIUM over the fake PAPER GOLD (has more makeup on it than Tammy Faye, God rest her soul!!) — can you hear me on that one?

“I say “fake PAPER GOLD” gold because the trading houses do not have the gold to cover all those paper promises. Paper is cheaper because if you really want to take delivery, you may not get it. Shoot, I wish I could sell you a piece of paper that has zero intrinsic value, but we save that for trading houses and the Federal Reserve! Or should I say the government saves those regulations for them who pad their re-election campaigns.
“It could also be seen as a supply/demand principle. There is a lot more paper than physical gold out there. Anyone thinking they can take delivery of their paper contract should take notice. Either explanation points to the same issue: Paper is not gold. It is tiny fibers of wood with ink on it. Or in most cases today, it is ones and zeros on your computer screen. When the lights go out, it is POOF — GONE!”


Addison Wiggin,
The 5 Min. Forecast

P.S. The extreme volatility we’ve been seeing in the markets can be great if you play your cards right. Our longtime options hotline operator Steve Sarnoff has seen his last five options trades increase 1,222% in less than 60 days.

“It’s a great time to be a financial writer,” a colleague said to me in the parking lot of 808 yesterday morning.

“That it is,” we replied.

To read the specifics about Steve’s trades going back through Aug. 17 and all the mayhem that ensued, click here.  

P.P.S. “Do you believe that if we had had a balanced budget amendment to the U.S. Constitution,” a reader writes longhand from Texas this morning, “forcing Congress to balance its budget every year based on good faith revenue estimates, that Congress might have been more careful, and perhaps been more vigilant, in preventing unwise home loans and would have been better stewards of public funds? Debt clocks, the Concord Coalition , continuous press coverage of the massive and growing debt, etc., have not seemed to have made an impact on our politicians or their behavior.”

The 5: First of all, thank you for taking the time to write your letter out on paper. No one does that anymore. It’s refreshing.

Unfortunately, I don’t share your optimism. Yes, absolutely, deficit spending should be illegal. Appealing to their collective conscience or sense of morality has had zero impact. The high-profile “sweeteners” in the bailout bill alone attest to that.
As we did with Empire of Debt a few years ago, we mailed a copy of the companion book to I.O.U.S.A. with this letter to every member of Congress. 

We included the reviews of the film from Roger Ebert , The New York Times , The Economist and Variety. Just as we did with the responses we got the first time around, we’re going to publish all the ones we get this time. The first arrived today:

One correction, Mr. Gonzalez: I’m a dude!


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