Prior Chart      
Chart In Focus

Deficits Are Good, Sort Of

Chart In Focus
January 09, 2015

A new Congress has been seated, and it brings the prospect of perhaps maybe potentially in a possible way doing something about the runaway federal deficits.  And in other news, several New York area bridges are for sale, which you can acquire at a bargain price.

Let us suppose, just for the sake of inquiry, that Congress ever actually did something to reduce the federal deficit, which would arguably be good for taxpayers (and for the grandchildren of taxpayers).  The question is: would that be a good development for current investors?

History says that no, it would be a bad development for investors.  This week’s chart looks at the Annual Federal Deficit expressed as a percentage of GDP.  The GDP numbers only go back to 1928, because it took until then for economists to invent the idea of GDP, which was previously described as GNP.  But the idea of government spending more than is taken in goes back a lot further. 

Over that time period, there have been 4 major instances of the annual deficit actually going negative (AKA a surplus), or in the case of the year 2000, to an almost negative state.

In 1929 and 1930, when Herbert Hoover was president, the federal government confronted the prospect of another depression like that of 1919-20.  Congress and the Hoover Administration responded in a similar way to what had worked before in that previous depression, by running a surplus just so that there would be reserves for the future.  The only problem was that it did not work for Hoover, perhaps because the Federal Reserve actually raised interest rates in late 1929, trying to be helpful.  This was the wrong medicine.

In the early 1940s, the U.S. government ran up a huge debt to pay for the military buildup in WWII, and financed by War Bond drives.  The result was a huge stimulus to the economy.  But then leaders figured that after the war they ought to pay back that debt, and so the government ran surpluses in 1947 and 1948 (#2 in the chart).  For the stock market, the result was a long drought that lasted until the federal government finally started running a small deficit again in 1949. 

There was another small surplus in 1957-58, #3 in the chart.  It did not seem to do much to the upward path of the DJIA, but it did indeed have a very real impact on the financial markets and the economy.  For example, 25% of those known as “customers men”, now called stock brokers, were laid off.  The DJIA may have continued higher into the 1960s, but the NYSE’s Advance-Decline line topped in 1956, and though that top was equaled in 1959, it did not exceed that level again until all the way into 2004.

You may have heard that there was a federal budget surplus in the late 1990s, during President Clinton’s 2nd term, and that episode is highlighted as #4 in the chart above.  Whether it was a surplus or not depends on which set of government statistics one chooses to believe.  The Treasury Department’s Monthly Treasury Statement (MTS) showed numbers which assert that a surplus existed.  But a separate part of the Treasury Department that is in charge of keeping track of the total federal debt shows that there was no actual shrinkage in the total debt from year to year.  See this and this.  So the supposed surplus was all accounting smoke and mirrors, since the total debt never actually went down. 

Still, just getting close to a surplus in 2000 was enough to kill the technology boom, and to usher in an economic recession that doomed President Clinton’s handpicked successor, VP Gore, to a defeat in the electoral college.  At that time, the total federal debt was only $5.6 trillion, which in retrospect is such a cute little number.  How times have changed.  Now total debt is at $18.1 trillion.

Ever since 2001, the federal government has been running big fat deficits every year, and the stock market has partied on.  Attempts to shrink the deficit in 2006-07 did help to usher in a stock market crash as the housing bubble collapsed, but since then there have been nothing but economically stimulative large annual deficits.  And Congress does not seem to be in any urgent hurry to change that condition, even though such a change might actually save the country from a fiscal collapse.  Congress has come to learn that it can count on a compliant Fed to bail us all out, so Congress does not seem eager to exert the type of real responsibility over the deficit which might injure our nice stock market uptrend.

One other point history shows us is that if the federal government ever were to run a surplus again, it would be a big negative for gold prices.  Here is a chart comparing gold to the MTS-quoted deficit as a percentage of GDP.  You can see the supposed surplus in 1998-2001, which coincided with an historic low for gold prices.  Over the past 4 years, deficits have been falling, and gold prices with them. 

US federal deficit versus gold

So if we were ever to get back to an actual budget surplus, the implication is that things would not go well for gold traders. 

All of these insights create a big conflict for investors.  Do you wish to be a patriot, and not see your country reduced to a pile of ashes through excessive spending?  Or do you wish to see your gold and stock holdings do well thanks to continued federal deficits?  When contemplating this question, cognitive dissonance sets in, and it is hard to know what to think. 

But if one can be of two minds at the same time, then one can perhaps argue emphatically and patriotically for budget surpluses, so that our grandchildren do not have to be enslaved by our own debts, while at the same time preparing one’s investments for what is actually happening, the better to be prepared to help when things get even worse. 

Tom McClellan
Editor, The McClellan Market Report

Related Charts
Apr 10, 2014
Enable Images to see this Chart
Household Debt Shrinking
Dec 09, 2011
Enable Images to see this Chart
What Debt Default Means For The Stock Market
Feb 26, 2010
Enable Images to see this Chart
Oil’s Leading Indication for Stocks