Has the American economy become a "fear economy"? You bet. But there has been a shift. For the financial markets at least, fear of the recession has morphed into terror about what the government is doing to deal with the reason. This is what CNBC's Rick Santelli was talking about yesterday with his call for a Chicago Tea Party. Stocks have lost more than fifth of their value since President Obama was elected. But the fear is more widespread than just that. As a new paper from the Tax Policy Center notes, the price of purchasing insurance against default on 5-year senior U.S. Treasury debt rose from around 10 basis points before September 2008 to above 70 basis points in early 2009. What are bond investors so worried about? Maybe they see the same fiscal future, trillion dollar deficits as far as the eye can see, as do report authors Alan Auerbach and William Gale:
In 2009, the federal deficit will be larger as a share of the economy than at any time since World War II. The current deficit is due in part to economic weakness and the stimulus, and in part to policy choices made in the past. What is more troubling is that, under what we view as optimistic assumptions, the deficit is projected to average at least $1 trillion per year for the 10 years after 2009, even if the economy returns to full employment and the stimulus package is allowed to expire in two years. The longer-run picture is even bleaker. We estimate a fiscal gap – the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt/GDP ratio at its current level –about 7-9 percent of GDP, or between $1 trillion and $1.3 trillion per year in current dollars.
And to close that gap, Auerbach and Gale says, we would have to cut all government spending by 23 percent or hike taxes by 52 percent. And, of course, deficits are just part of the problem. There is also the issue of a "share the wealth" rejiggering of what American capitalism is all about. Reward the losers and punish the winners. But the bottom line is this: Obama's economic plans cannot work with the cooperation of the markets. Falling stock prices mean people and business will continue to cut back on spending, and eventually higher interest rates will slow borrowing due fear of monstrous deficits.