Obama’s Megatrillions for Change

Many around the world celebrated  as they watched the inauguration festivities in Washington DC.  Barack Obama warned Americans that the challenges they face as a nation are numerous and grave, requiring individual sacrifice and difficult choices to plot a path back to prosperity.  While he spent a few minutes speaking to the world, he avoided asking them for their contribution to America’s renewal; the purchase of $5 trillion of new US debt to cover a half decade of enormous budget deficits.

Americans, you see, have had a negative savings rate for the last decade and do not have the personal savings to buy new federal debt issues.  The last time America faced an enormous demand for debt was during World War Two, and Americans could comply because they had a positive savings rate and there were few consumer goods for them to purchase with their dollars, since most production had been redirected for the war effort.  Corporate America and the banks are in no condition to help either, with business profits down and the banks receiving government bailouts or quasi-nationalizations.  Smaller nations like Canada may have some lending capacity, but we will need our liquid resources as well to absorb our own coming federal deficits.

Where are the US’s traditional lenders, China, Japan and, to a lesser extent, Russia?  The US Treasury may be surprised to find that they lack the funds to absorb new US debt as they have over the past 15 years.   The Japanese are suffering from a relatively high Yen that is reducing their foreign income and the worldwide recession is exacerbating the problem by reducing demand at the same time.  The Japanese economy suffered a prolonged decade-long recession during which their government accumulated massive debt and deficits of their own, compromising their ability to act as a relief banker for the US.  Much of the US real-estate that the Japanese invested in during the 1980’s is falling in value as the US housing meltdown is morphing into a commercial real estate decline as well.  In short, the Japanese are in no position to help out.

The Chinese were able to purchase over a trillion dollars of US debt because they were receiving much more than that in income from the consumer goods that they sold to Americans up to this point.  The decline in US consumption has provoked a recession within China; massive job losses and factory closings have shocked the population into curtailing their spending as well.  Not only are the Chinese without their habitual foreign income, they are now forced to spend trillions of Yuan to stimulate local demand and investment.  The Chinese were already uneasy about the nearly $1.5 trillion in US debt and securities that they already hold; they do not have the desire, nor the capacity, to acquire further US-denominated financial instruments.

The Russians have enjoyed an economic resurgence due to world demand for their oil and gas reserves.  Plunging prices for oil, from $147 per barrel last summer down to the mid-$40’s today, coupled with natural gas prices below $5 US per thousand cubic feet have created an income crisis for that country as well.  While energy prices are likely to recover into 2009-10, Russia’s uneasy relationship with the US as it seeks to reassert its presence on the world stage means that it is unlikely to share its wealth with its old rival.  Russia is better off buying new debt from the EU countries that will be running massive deficits of their own, in order to gain influence with their governments and delay or halt the expansion of NATO into previous Soviet-block nations.

Obama has already declared that there will likely be a $1 trillion or higher deficit for fiscal 2009-10 with no foreseeable decline in that figure on an annual basis for several years to come.  The current US federal debt stands just short of $11 trillion; by the end of Obama’s recovery period, that debt will likely rise to $16 trillion.  So where is the buyer for all those bonds yet to be issued?

America may have to turn to its own people to find the money, at least for the first few trillion while their traditional international bankers rebuild their economies and redevelop the capacity to lend internationally.  Obama will have to create a bond-drive program similar to the war bonds campaigns of WWII, asking Americans to invest in their government and their own future.

There are several problems facing Obama as he seeks to finance from within.  Since the US savings rate is still negative, Americans will have to de-leverage their consumer debt in order to be able to free up the cash flow to purchase government securities.  America’s financial institutions and pension funds could also purchase US government debt, but this would likely remove these funds from the commercial and residential credit markets that are already starving for new sources of financing.  The irony of this problem is that if the US government is successful in selling its new debt to Americans, it is likely to prolong the recession or stretch out the recovery as it “crowds out” other potential avenues for the same money in the marketplace.

Can Canada find buyers for its debt?

In comparison to the US, Canada is well positioned to sell new debt to cover the federal government’s return to deficit spending.  Last week, the government announced that the federal deficits for the next two fiscal years would total $64 billion Canadian dollars.  Canada’s Liberal and Conservative government’s paid down over $120 billion in old debt since the federal government began posting surpluses in the mid-1990s and our economy will not suffer a recession nearly as deep as the ones underway in the US and the balance of the G7.  Indeed, if energy prices recover through 2009 as many expect, our economy may not post negative growth for 2009 and tax revenues may be higher than currently expected.  Bank of Canada Governor Carney is calling for a substantial contraction in the first quarter of 2009, then recovery; he may be too pessimistic in his predictions depending on how quickly China and India redevelop their appetites for oil and metals.

Prepare for tensions and jealousies across the border

The US and Canadian economies will be on divergent paths for some time; Canada will suffer a shallower recession and will recover more quickly, resulting in proportionately less financial strain on our government.  US lawmakers, looking to protect US jobs may incorrectly conclude that Canada is enjoying unfair advantage under NAFTA and will pressure Obama to make good on his election-campaign promise to re-examine the agreement.  Obama may have to put this item on the agenda in exchange for congressional support for stimulus initiatives in subsequent years’ budgets.  Canadians should not be smug that we are better positioned than our US brethren.  Our economic fates are tied together, and the Canadian government should try to coordinate economic recovery policy initiatives with the US in order to demonstrate our view that we have a North American economic partnership that should not be allowed to devolve into a rivalry.