The Budget Deficit: How "bad" is it?

As one looks at the precision with which the various official data is dissected throughout the media, one would assume that there exist defined standards for what numbers "should be" under "normal" conditions. (Whatever "normal" means.) I have frequently heard clients describe economic conditions as one way when I, or my industry colleagues have a very different interpretation of the same facts or figures that are widely reported and universally regarded as important bell-weathers. I find this to be the result of widely different views expressed depending upon the news outlet and a lack of historical perspective by both journalists and readers. In particular, there is a wide cleavage in basic analysis between financial journalists in the mass media, the reporters in the financial press, the professional investment community's own analysts, and politicians who, in a 24 hour news cycle, feel compelled to provide an opinion of every piece of data - even before any economic or financial professional has done so.

The recent revelation that the federal budget deficit in 2009 will be larger than predicted - and a new absolute value record at $490 billion has been described as evidence by the Democratic leadership that the country is rapidly deteriorating. Budget Committee Chair Sen. Kent Conrad blasted the administration for being "reckless" and commented that George W. Bush "will be remembered as the most fiscally irresponsible president in our nation's history."

The current deficit equates to approximately 3.3% of the projected 2009 US Gross Domestic Product. While the dollar number is historically high, its actual impact is pretty much in-line with history and the current budget status other developed countries - most of the EU economies have run equivalent budget deficits to the US in recent years. The US government has rarely run a surplus in the last century and 3.3% is pretty much "normal" for historic patterns of deficits and in the range of what seems to be an "ordained" and structurally tolerable rate of 3% enshrined in the EU's monetary accords for its member states. Accordingly, policymakers and institutional investors are likely to share a similar mindset on the current budget numbers (at least privately). However, expressing outrage is likely to remain popular among opposition politicians as long as the number is negative. I suspect that the institutional investor community looks at these matters relatively (i.e. what are the deficits for other developed countries?), and like individual investors on unemployment - are more responsive to the trajectory of the number, rather than its value.

Going forward, expect that policymakers globally will see 3% as goal- above "bad", below "good. Unfortunately, there's a fundamental disconnect here between policymakers and the general (and investing) population. They are likely to view any negative number as "bad" any only will interpret a negative number as "good". Opinion polls consistently show strong support for balanced budgets and concern for the deficit. This "unexpected" increase can largely be attributed to the federal governments' stimulus package. Ironically, the deficit would have been smaller than expected had the bipartisan stimulus package not been implemented. This is an example of both institutions and politicians viewing things very differently from the man on the street.



The balance of the budget is an area that may be viewed with a degree of neutrality by institutional investors, and be a matter of party affiliation (largely) by politicians, but to the individual, the matter is clear. They don't like deficits and they act as a depressor of public opinion. Thus, a budget deficit is likely to influence investor behavior negatively if its perceived as "bad" and the trajectory is negative.