In response to a federal budget deficit spiraling to heights not reached since WW II, the administration is starting to turn its attention toward America's fiscal position. In tonight's State of the Union address, President Obama will likely refer to a new proposal to freeze parts of the budget over the next few years. What is the upshot of this proposal?
Spitting into a hurricane
The areas that are targeted for a freeze fall under non-defense-related spending (not to worry, Boeing (NYSE: BA ) , Lockheed Martin (NYSE: LMT ) , United Technologies (NYSE: UTX ) , and General Dynamics (NYSE: GD ) ); unfortunately, they only represent about one-eighth of aggregate spending.
This move is purely symbolic in terms of its impact on the budget deficit. The only comfort it provides is as evidence that the administration is somehow aware of the problem. The greatest threat to the government's long-term fiscal position is entitlement costs, specifically, those linked to Medicare/Medicaid. The Congressional Budget Office expects that, under current law, spending on both of these programs will continue to grow faster than the economy through 2020, potentially reaching 10% of GDP by 2035 -- that is clearly unsustainable.
A warning from the East
Obama has repeatedly promised that there would be no increase in taxes on the middle class, all the while trying to expand access to health care (in a manner that is supposed to be deficit-neutral!). Economics can be subordinated to politics for a long time -- but not eternally. The White House should look East for an illustration of the consequences of fiscal incontinence: Greek bond yield spreads reached a euro-era high this week, as reports surfaced that Goldman Sachs (NYSE: GS ) is struggling to persuade the Chinese government to buy up to 25 billion euros of Greek government bonds.