Predictable Government Windfall

With the ongoing equity market correction, and possibly the start of a bear market, it's time to revisit a concept we touched on in How They Got us Into This Mess. The government windfall that results from a credit created boom. This latest credit created boom is just another up leg of what, in reality, is a debt fueled bubble that has been going on for over 80 years and must eventually fail.

Much of the debt taken on recently has been by the government, but new, record amounts of debt is also adding to the burden of car buyers, corporations, students, and of course, traders and investors using margin debt to buy stock. The fed has even managed to prevent the real-estate mortgage market from contracting to a reasonable level with ultra low interest rates and direct intervention in the mortgage market through QE.

If you can believe it, the government balance sheet has been one of the biggest beneficiaries of this ramp up in total credit market debt. As employers believe that good times are here again and here to stay, they start to hire more employees, granted this "recovery" has seen pretty anemic growth, but some jobs are being created. They tax the income from this increased employment. Corporate earnings have also seen a bump, which is also taxed. Finally the income from the sale of stocks is also taxed. All of this helps the government's finances even if the deficit was at very frightening levels at the beginning of this "recovery". And the reason I put recovery in quotes is because if the recovery can't be sustained it is merely an illusion, and as Von Mises said "There is no means to avoiding the final collapse of a boom brought on by credit expansion."



There was an old saying several decades back that if the US economy sneezed the rest of the world economy caught a cold. This was to imply that the US was such a large economic force that any issues in the US would reverberate throughout the world. Now there is a rival to the US, and while there are some metrics that say the US is still #1, the Chinese economy is the largest importer and exporter, and they have done much more than sneeze. It goes without saying that the Chinese are having major problems. The Chinese problems are already spilling over to the US, will likely continue to do so, and worsen. Despite the rosy picture the mainstream media is attempting to portray, most understand hard times are likely ahead. This is supported by the commodity crash, particularly one of the best prognosticators, Dr. Copper, and of course oil. Weak commodity prices have been a bellwether the past several major economic downturns, and the severity of the drop in commodity prices does not paint a pretty picture if that trend continues.

Even with the latest, albeit questionable, bump in US GDP there are many arrows pointing towards the R-Word, recession. As mentioned above the equity markets may also be indicating a turn for the worse. Many of the stocks are still being sold at a gain and providing a helping hand to government finances, but if the market downturn continues, watch out. Those taxed gains will turn to tax deductible losses, and corporate taxable earnings will also fall. Not only will the government not see an increase in taxable personal income from increased employment, they will be forced to start forking over more toward unemployment benefits and other entitlements as people lose their jobs.

Many believe that the policies of Bill Clinton along with the Republican congress caused the surplus of the late nineties, but the truth is the surplus was the result of Greenspan's credit induced boom, known as the dotcom bubble. Hindsight makes it clear most of this "growth" and improvement in the government balance sheet was a farce. Democrats try to give credit to the president and republicans to Congress for presiding over reducing deficits in the mid 90's, but these improvements were nothing but a debt bubble providing a government windfall. The current administration likes taking credit for reducing the deficit, but again this temporary trend of shrinking deficits will reverse, likely in spectacular fashion. To do this concept justice words fall short.




This chart shows it all, prior to the recession of the early '80's the deficits increased, and accelerated.By the end of the 80's the deficits began to recover as the private sector joined the government in the borrowing binge. Then the deficits began to increase, again warning of a recession.The same pattern accompanied the dotcom bubble and resulting recession. Finally you can clearly see the recovery in the governments balance sheet and subsequent massive deficits that took place during the real-estate bubble.

We have witnessed the pattern of accelerating total credit market debt resulting in a temporary economic boom. This boom results in a windfall for government finances but always results in a rapid increase in deficits that more than wipes out the improvements seen during that windfall. Though I am sure there are others that have brought up this issue, I have not noticed it directly, which is surprising considering how much I research economic and financial matters. It seems like such a simple, obvious and verifiable concept that would garner more attention, but I am sure there is a reason for the lack of discussion about this pattern from mainstream outlets.

The next time you hear a supporter of the Obama administration touting how much he has reduced the deficit, consider the very clear pattern of credit boom, crash, recession and spiking deficits, and what will happen to the governments balance sheet when the other shoe drops.

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