As federal aid to banks decreases, 2009 deficit estimate gets trimmed

Put this one decidedly in the good news category: the Obama administration is expected to announce a $262 billion reduction in this year's budget deficit to $1.58 trillion.

Earlier, the Obama administration had forecast a $1.84 trillion deficit for the current year, Bloomberg News reported. The new projection, to be released next week in the White House's biannual budget review, shows a large decline in forecast outlays, primarily due to fewer bank failures and less related support required to stabilize the financial industry.

One telling example of the improved fiscal outlook: spending for the Federal Deposit Insurance Corp. (FDIC), which is now projected to be $78 billion less than the previous forecast -- an enormous reduction, in any situation.
The Congressional Budget Office's most recent deficit forecast for this year is $1.825 trillion.

The last time the United States recorded a budget surplus was in 2001, during the last budget year of the Clinton Administration.

In its earlier estimate for the current year, the Obama administration forecast a record $1.84 trillion deficit -- boosted higher by the banking bailout to stabilize the financial system and the fiscal stimulus package to jump-start the U.S. economy. The administration forecasts a $1.26 trillion deficit for next year, fiscal year 2010, which begins October 1, 2009. Last year, fiscal year 2008, the U.S. government posted a then-record $454.8 billion deficit.

Lower deficit: Good news for investors

Further, if the new, lower $1.58 trillion deficit is announced as expected next week, it would be good news for investors, large and small. Moreover, it's not a stretch to argue that U.S. stock markets would respond favorably to the news.

That's because although the deficit would still be very large in percent of GDP terms, 11.2 percent compared to the earlier 12.9 percent, it strengthens the argument that federal outlays for the financial crisis are trending lower. This suggests that the United States is on the road to a 'normal' fiscal environment, one with functioning financial markets, a recovering economy, and shrinking deficits. In other words, from an investor standpoint, at this stage of the financial crisis and the economic cycle, the direction of the deficit trend matters just as much as the size of the deficit.

Large investors in U.S. debt would no-doubt cheer the lower deficit news. Bond owners China, Japan, and Saudi Arabia, as well as Russia and Brazil, among others, have repeatedly expressed concern that the U.S.'s high budget deficit will result in additional dollar declines versus the euro, British pound, Swissfranc, and yen -- further decreasing the value or purchase power of their dollar-denominated investments.

Fiscal Analysis: Simply, after job growth, the major problem facing the United States is the budget deficit. Hence, once the U.S. economy is recording sustainable GDP growth, the nation must initiate actions to reduce, then eliminate the deficit. Further, any less-than-expected federal outlays for the banking sector would represent a nice tailwind in this process, but much heavy-lifting will remain, including: health care reform and corresponding entitlement reform, the elimination of needless federal programs, substantial cuts in non-essential defense programs, and, if necessary, a tax increase for citizens earning more than $250,000 per year. Finally, 'no' is not an option regarding deficit reduction: the United States must get its fiscal house in order to keep interest rates low, stop the dollar's slide, protect the value of U.S. investments, and maintain the nation's status as an attractive place for investment capital.
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