The High Cost Of The U.S. Budget

David Malpass and Eric Singer, 02.08.10, 03:10 PM EST

Remember the ending of ''Thelma and Louise''? This is worse.

Early last week the administration unveiled its new $3.8 trillion budget. This budget, and the spending it assumes, is so reckless it is difficult to fathom. It projects a deficit of $1.6 trillion for fiscal 2010, with an explosion of publicly traded government debt to $18.5 trillion by 2020. Debt service is projected to reach $912 billion a year by 2020, or over $5,000 for every working person in America.

Even assuming that wages grow over time, the budget suggests the government believes that as U.S. citizens we should devote 10% or more of our grossincome just to pay the interest on the federal debt. That 10% comes out of income even before people start paying for actual government programs like national defense, health care, bank rescues and welfare. Nor does it count the spending people need to make for state and local government obligations and their own mortgage and credit card payments.

The administration clearly believes that we can spend our way out of a slow economy and has put us on a path to have total government spending over 40% of GDP. This is Disneyland thinking. While it is true that we can spend our way into a depression, there is little evidence we can spend our way out. It didn't work last year, when we allocated $ 787 billion in stimulus spending on the threat that unemployment would go over 8% otherwise. (It is now at 9.7%--16.5% if you count the underemployed and those who are too discouraged to look for work.) Excess spending didn't work for President George W. Bush. It didn't work for Presidents Roosevelt or Obama.

When the government spends $3.8 trillion, there is no net multiplier effect. There is a divider effect. We become divided from our income and wealth. The government taxes inefficiently and spends inefficiently, wasting a big chunk of the transfer. Yes, it is possible for purposes of a speech anecdote to find isolated beneficiaries. The government will soon be able to claim massive "job gains" for temporary workers for the 2010 census. But much government spending misallocates resources--it's distributed without a profit motive and with frequent conflicts of interest, including an eye toward political returns rather than longer-term growth and private sector jobs.

Markets are waking up to the fiscal crisis. The price of a credit default swap for a five-year U.S. Treasury has gone up 700% since 2007, from about 8 basis points to 56 basis points. Germany, at 40 basis points, is now deemed by the market to be 28% less likely to default than the U.S., and the difference is growing. More ominously, the U.S. swap has more than doubled in price in the last few months. As recently as 16 months ago Greece was at levels we are today. When a country goes past owing 100% of its nominal GDP in publicly held debt, as this budget schedules us to do by 2020, there is danger.

Given our politicians' willful innumeracy, perhaps the best way to understand what the budget does for us is to compare it with the movie Thelma and Louise. For those who never saw it, Thelma and Louise was a film about two women on a supposedly liberating road trip. Toward the end, running out of money, they rob a convenience store and blow up a gasoline truck for fun. FBI agents close in on them, and they decide to drive their car off a cliff. In a Hollywood ending they are shown with a look of joyous freedom while they are in free fall.

Like Thelma and Louise, we are spending beyond our means, and at some point the bond vigilantes will close in. With this budget we almost guarantee that the United States AAA debt rating will at some point be called into question. If and when it is, the result will resemble the downward arc of that terrific 1966 Pontiac Thunderbird. In real life, at the end, when you go off a cliff at 100 miles an hour, gravity takes hold, and there is a fiery crash.

David Malpass is an economist and president of Encima Global LLC. He writes a column for Forbes. Eric Singer is the president and portfolio manager of the Congressional Effect Fund (CEFFX).