Tick Tock Toward Midnight

From this morning’s Wall Street Journal:

President Barack Obama’s 2012 budget proposal projects this year’s deficit will reach $1.6 trillion, the largest on record, as December’s tax-cut deal begins to reduce federal revenues, a senior Democrat said Sunday.

The new forecast is larger than the $1.48 trillion deficit projected last month by the Congressional Budget Office, Congress’s nonpartisan scorekeeper, and up from last year’s $1.3 trillion shortfall.

Mr. Obama and the Republicans are choosing to clash over a narrow slice of federal spending—the 15% devoted to discretionary programs unrelated to security and defense—while the entitlement programs that are driving projected federal deficits remain unaddressed by either party.

For a moment or two Americans increased their personal savings rate in the wake of the subprime mortgage meltdown, but it’s already sliding back toward a meaningless level that will build no capital for households to use in wealth-building efforts later. In the second quarter of 2009, households saved 7 percent of their disposable income. That was a big improvement over 2007’s third quarter and its paltry 2-percent savings rate. In December, however, the rate slipped to 5.3 percent sparking alarm that the once-promising age of capital accumulation wasn’t an age at all, but rather a flirtation.

To address this issue, the New York Times hosted a “Room for Debate” discussion last Tuesday titled, “Why Aren’t You Saving Money?”

In that discussion, Center for European Policy Studies director Daniel Gros said the focus on household savings misses a key point: “what matters for a country is not only how much households save, but the national savings rate, i.e., the sum of savings of households, the corporate sector and the government.” Recent increases in private savings have “been offset by the explosion of the government deficit.” He concluded:

The purpose of savings is to allow a country to finance its investment needs with its own resources. The US is today even less in a position to do so than before the crisis. This becomes clearer when one looks at the net national savings rate, i.e., what remains of national savings after the expense needed to keep the existing stock of capital intact.

For the first time, the net savings rate of the US has turned negative. This is a first for a large OECD country. In Europe, only two small countries are in a similar situation: Greece and Portugal. At negative net national savings, the US is eating into its capital stock instead of adding to it. This cannot go on for long without sapping the recovery and putting the American economy at the mercy of international capital markets.

We’ve been monitoring this situation closely in The Kelly Letter for a long while now. We don’t expect the imbalance to be repaired before it turns catastrophic because, as the Journal pointed out, no politician is willing to tackle “the entitlement programs that are driving projected federal deficits.”

The apparently inevitable catastrophe is one of the catalysts we see driving an eventual second leg down to new lows in the stock market. Eventual is the key word, I’m afraid, because the government and Federal Reserve are doing everything in their power to prop up financial markets until the bitter end.

In the meantime, it’s easy to see where the trail of connected dots leads.