“Why would they want to do that?” 2012 Budget Inflation Assumptions

"America is not broke," Moore said "the country is awash in wealth and cash ... It has been transferred in the greatest heist in history from the workers and consumers to the banks and the portfolios of the uber-rich." Source: Wisconsin State Journal; dwahlberg@madison.com; http://host.madison.com/wsj/news/local/govt-and-politics/article_8a60e128-4791-11e0-9892-001cc4c002e0.html

Technically he may be right, but it’s not going to help us much to be "technically right".

My background is 30+ years in the healthcare finance field with most of those years at a senior management or CFO level. My training is accounting with a Masters and CPA. So I have a background for what I'm writing. My only concern is for the future of my grandkids and others like them. I'm not sure what Mr. Moore's motivation is?

Something isn't "right".

I started downloading the White House Office of Management and Budget Summary Schedules (found on their website) in 2009 (2010 budget). I was curious how they might have calculated the Net Interest Expense for the budget years. I came away concerned with their overall budget projections since I felt they had used very optimistic assumptions for each of the 5 key budget assumptions (growth, inflation, unemployment, short term interest rates and long term interest rates found on Table S-13). Using overly optimistic values for each of the assumptions would make the resultant projections very unrealistic.

In 2010 (2011 budget) I decided to create historic databases on each of the five key assumptions to test their reasonableness and came away concerned that historical trending couldn't support any of the five, let alone all five of them. That year I calculated the amount of understatement in Net Interest Expense and National Debt would be based on the understatement interest rates. I estimated it to be over $3.5 trillion dollars.

This year I concentrated on what I thought would be the most important of the high level assumptions, inflation. In the budget they call inflation "Consumer Price Index, percent change, year to year". I Googled "CPI" and found a government website from which I could get historic annual inflation numbers. I compared those to the average (2.0%) and maximum (2.1%) inflation assumptions in the 2012 budget. I was stunned with what I found. We've haven't had a decade with a 2.0% average inflation rate since before the 60's and we've only had 7 years, most during recessions, that were at or below the 2.1% maximum inflation rate they show in their projections for the years 2012 - 2021. It turns out they are using the Fed Target Rate for their maximum inflation rate despite the fact we routinely surpass it.

Why would they use such unrealistic numbers in putting out the budget projections. There might be two reasons:

First, compounding. There's is a concept in math and finance called compounding rate. The old example was 7 and 10. If you earn 7% a year for 10 years you can double your money, but if you can earn 10% per year you double it in 7 years." Simply the put, higher numbers double more quickly and lower numbers double slower. Imagine how much longer it takes spending to double at 2.1% inflation as opposed to a more realistic 3.5% inflation. And back in the 70's and early 80's it didn't take long to double at all with inflation over 7.0%. This means they create much more acceptable numbers for Outlays, Deficits and Increase in Debt by using lower inflation assumptions than higher ones. I order to make sure that they weren't doing the same thing other administrations had done, I looked up four other budgets (2009, 2007, 2005 & 1997) and found the maximum inflation assumption for those averaged 3.1%. While still below historical trending, it was significantly above what this WH OMB has used. Finally I tested the 2011 projection of 1.3% against what we've already seen this year (Oct - Sep fiscal year). We've already reached this year's annual assumption In February and still have most of the year left.

The second ties to something Chairman Greenspan used to tell Congress about interest rates. He told them that Interest rates follow trends in inflation and inflation follows trends in government spending. In otherwise, if you project lower inflation rate assumptions, then you can also use lower interest rate assumptions. And the 2012 budget uses very moderate to low interest rates. That in turn results in understating Net Interest Expense, Outlays, Deficits and Increase in Debt. I also found we are currently well above their 2011 average annual 10 Year Treasury assumption of 3.0% with the rate close to 3.5% at the end of February.

So I'm left wondering "What's going on here?" While M. Moore may be technically correct that there is a lot of cash around and we aren't totally broke, we are running very significant deficits and watching our debt increase at an alarming rate. Soon we will be faced by a catastrophic increase in Net Interest Expense that will overwhelm the budget. If you don't believe it, just compare the level of Net Interest Expense we paid in 2010 to what the average annual Net Interest Expense was during the 90's and that was with about one third the National Debt we currently have. That's what a Fed Fund rate under 0.2% will do for you.

90's Average: $216 billion Net Interest on $4.6 trillion debt (Fed Fund Rate of 5.2%)
2010: $197 billion Net Interest on $13.4 trillion debt (Fed Fund Rate of 0.18%)

It appears this administration is now using the Budget process as merely a political tool to achieve their ends. Unfortunately it appears their political ends include misleading us as to the extent of the financial crisis we are facing. So ask yourself this. "Why would they want to do that?"

This year's summary schedules show up in Table S-13 on page 202 of the Summary Tables found on the WH OMB website.

2012 Budget = http://www.whitehouse.gov/omb/budget/Overview (choose last item Summary Tables)
Inflation tables = http://www.bls.gov/cpi/tables.htm (choose top item)