U.S. facing biggest deficit in 60 years: CIBC World Markets report

Dec 1, 2008


    Bailout strategy may not help domestic automakers

    TORONTO, Dec. 1 /CNW/ - CIBC (CM: TSX; NYSE) - President-elect Obama can
expect to face the biggest U.S federal deficit since the end of WWII when he
takes office in January, finds a new report from CIBC World Markets.
    Before his administration adds on its own stimulus package, the Treasury
market will need to finance a minimum of $1.5 trillion of new debt, if not
more, pushing the federal deficit to 11 per cent of U.S. GDP. And this will be
before the full brunt of the cyclical deterioration in tax revenues that
accompanies a recession, has been felt.
    At this level the deficit will be larger, in relation to the overall size
of the economy that supports it, than the red ink ran up during either the
Korean or Viet Nam Wars. In relation to the size of the economy, it will be
bigger than any deficit since 1946.
    "Find a strong enough wind and even pigs can fly," says Jeff Rubin, chief
economist at CIBC World Markets. "If you force-feed a $14 trillion economy
with $1.5 trillion of fiscal stimulus, GDP growth will respond. But what about
the trail of record deficits that lay in the wake of such fiscal action? How
many years of program spending cuts and tax hikes will it take to whittle down
such a massive deficit. Will future taxpayers simply wish we had bitten the
bullet for a few quarters and not mortgaged their future?"
    Mr. Rubin says that while politicians and financial markets are currently
worrying about deflation risks, history has shown inflation to be a far more
common dancing partner for massive government deficits. He notes that by
monetizing debt by simply selling the bonds and bills to the Federal Reserve
Board instead of the public will drive inflation - and that may be a good
thing for government.
    "The resulting higher inflation allows the government to pay off
bondholders with coupons that have less and less buying power every year,"
adds Mr. Rubin. "And while the bonds mature at par, inflation will have eroded
much of their real value. And higher inflation ultimately brings down the
value of your currency, which is a huge benefit, if you are the U.S. and can
get other countries to lend you their hard-earned savings in your currency.
    "That allows you to repay your lenders, like the People's Bank of China,
with greenbacks that buy a lot less Yuan than they did when China first lent
you the money. And aside from stiffing your creditors, higher inflation is
bound to rub off on asset values, like housing prices, for example. That would
certainly boost the value of all those mortgage-backed securities that the Fed
is now buying."
    An area of the economy Mr. Rubin does not think will be saved by a
government bailout is the domestic auto sector. While he recognizes that a
Chapter-11 reorganization, levered with billions of dollars in taxpayer-funded
assistance, may allow the Big-Three to stay in production and win much needed
concessions from its unions and creditors, he does not see this resolving
questions of long-term viability.
    "The issue is not simply the competitiveness of North American auto
producers but the size of the market they will serve in the future," notes Mr.
Rubin. "A secular rise in gasoline prices and a lengthy period of consumer
deleveraging is fundamentally altering both the size and composition of the
U.S. auto market. Currently, U.S. car makers are not only making far too many
SUVs for customers who want smaller and more fuel efficient vehicles, but more
ominously, their production capacity seems grossly oversized for what is
likely to be a steadily shrinking North American vehicle market."
    The report notes that since gasoline prices hit their peak in June,
vehicle sales have plunged 50 per cent, which is larger than the drop in sales
after the first two oil shocks. While it took as long as 10 months for sales
to recover after the first two shocks, Mr. Rubin is not certain sales will
rebound this time. In fact, while gasoline prices have dropped dramatically in
the last six months, the decline in auto sales continues to accelerate. The
latest monthly sales numbers in the U.S. have dropped below 11 million units,
levels not seen since 1983, following the infamous double-dip recession of the
early 1980s.
    Mr. Rubin thinks two powerful forces will keep sales from rebounding -
energy prices and the end of cheap credit.
    He notes that oil prices collapsed after the 1982 recession and remained
cheap for the next two decades as the oil shocks spawned greater efficiency
and new supply from places like the North Sea and Prudhoe Bay in Alaska. While
in percentage terms, prices have collapsed as much since the start of summer
as they did after 1982, the resulting levels are very different. While $50 per
barrel oil is only a third of the peak level of $147 per barrel seen in July,
it is a level that only four years ago would have denoted an all-time high
price for petroleum.
    With the world's new oil supply largely tied to high cost oil sands and
deep water wells, many new supply projects are being postponed or cancelled.
As a result, there is a very real chance that world supply will contract in
the face of depletion rates that every year take out some four million barrels
per day of production.
    Mr. Rubin believes the end of cheap credit may be almost as important as
the end of cheap oil in putting the brakes on future vehicle sales. Over 90
per cent of all new car purchases require financing of some kind. The past
twenty or so years not only saw a housing bubble that was fuelled by easy
access to credit on favourable terms, but it also applied to automobiles as
well. During this period, U.S. vehicle sales reached a peak of over 20
million, and household car ownership rose from 1.9 vehicles per household in
the early 1990s to 2.2 in 2007.
    "Like today's home buyer, today's auto buyer is finding financing harder
and harder to come by," adds Mr. Rubin. "Particularly those looking for lease
financing, who until recently had accounted for almost 30 per cent of all new
vehicle shoppers. But leasing is a rapidly diminishing source of vehicle
financing.
    "At a time when there is a growing crescendo of calls for greater
infrastructure spending, it is noteworthy that there will soon be fewer and
fewer Americans on the road. The shrinking size of the domestic car market
suggests that investment in public transit, as opposed to new freeways, would
be a far better infrastructure choice."The complete CIBC World Markets report is available at:
    http://research.cibcwm.com/economic_public/download/snov08.pdfCIBC World Markets is the wholesale and corporate banking arm of CIBC,
providing a range of integrated credit and capital markets products,
investment banking, and merchant banking to clients in key financial markets
in North America and around the world. We provide innovative capital solutions
and advisory expertise across a wide range of industries as well as top-ranked
research for our corporate, government and institutional clients.




For further information:

For further information: Jeff Rubin, Chief Economist and Chief
Strategist, CIBC World Markets at (416) 594-7357, jeff.rubin@cibc.ca; or Kevin
Dove, Communications and Public Affairs at (416) 980-8835, kevin.dove@cibc.ca


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