CBO Debt Projections: Make Room for “Crowding Out”

by Addison Wiggin (Daily Reckoning)

03/08/10 Baltimore, Maryland – The latest deficit projection from the Congressional Budget Office was conveniently revealed just prior to the close of business on Friday.

“Why so?” You ask suspiciously.

“Because,” we respond in a hushed tone.

The CBO’s latest numbers reveal that President Obama’s proposed fiscal 2011 budget would add $9.7 trillion to the national debt over the next 10 years. The White House projection is only slightly less staggering – $8.5 trillion.

Further, the CBO projects the national debt will be 90% of GDP by the end of this decade – higher than the 83.4% recorded at the end of fiscal 2009 last fall. We’re 100% certain this comment will elicit the customary response: “Look at Japan, its debt is 170% of GDP…and it’s been running massive deficits for years!”

To which we can only sigh and respond: “Exactly.” Then get back to our film in which we hope to illustrate the long-term deleterious effects caused by the “crowding out” effect, when governments spend their citizens’ future wealth…way ahead of schedule.

“We told you two months ago,” our economist-in-residence Rob Parenteau also revealed late on Friday, “we thought Greece would not default, it would begin to implement government spending cuts and tax hikes and there would be a backup fiscal assistance facility put in place for the region in the event bond auctions began to fail. So far, this is precisely how the scenario has played out.”

So far, so good.

But “the next act gets tougher to predict,” he cautions. “Greece and other countries now face falling private-sector incomes – that is, after all, the direct and immediate result of higher taxes on businesses and households and lower government expenditures. Unless the trade deficits of these nations can swing sharply into surpluses (as lower domestic incomes lead to less import demand and lower costs of production lead to higher exports), private debt defaults will now start to multiply and cascade through the system.

“Last week, Moody’s placed four Greek banks on downgrade watch. This is just the start – the fiscal retrenchment has only just begun to take effect. By taking these steps to avoid a public debt default, we would suggest these economies are now poised for more private debt defaults.

“We believe private investors do not yet get this connection, but it will be made very clear in the months ahead. Latvia, with a GDP collapse of nearly 25%, will become the next poster child of the region in this regard.”