The single biggest factor in the ballooning deficit was the bank bailout. The federal government’s Troubled Asset Relief Program, or TARP, led to almost $300 billion in new spending, while aid to troubled insurer AIG and mortgage lenders Fannie Mae and Freddie Mac came to another $60 billion. These bailouts accounted for more than half of the increase in the budget deficit.

About one-quarter of the increase in the budget deficit was because of a fall in tax revenues. With rising unemployment and business bankruptcies, the federal government collected about $150 billion less in taxes as compared to the same time last year. Another quarter of the budget deficit was due to increases in spending besides the bank bailout. The largest increase, at $25 billion, was for increases in unemployment insurance benefits, followed closely by a $24 billion increase in spending on the Department of Defense.

The huge federal budget deficit has caused the public debt, or the total owed by the U.S. government, to rise by a little more than a trillion dollars over the last six months, to a total of more than $11 trillion. This is more than 80% of Gross Domestic Product (GDP), the total of final goods and services produced in the United States in a year.

The huge Federal budget deficit raises two questions: first, can the U.S. government continue to borrow to bailout financial institutions, pay for the wars in Iraq and Afghanistan, fund the growing demand for unemployment benefits, food stamps, and other benefits, and spend on the economic stimulus package? Secondly, will the large budget deficits be able to stimulate the economy out the current depression?

So far the federal government has had no problem borrowing enough to finance the deficit. This is mainly due to a rush to buy U.S. government bonds instead of other, more risky types of debt, following the financial crisis that exploded last September. Foreign investors, banks and businesses have been the biggest buyers, which has boosted the value of the dollar. Money market mutual funds and financial security dealers and brokers have also shifted to lending to the

federal government.

But with growing public opposition to more bank bailouts, and growing concern in the rest of the world that the U.S. budget is out of control, the government is planning to shift even more of the financial market bailout to the Federal Reserve, the U.S. central bank. The Federal Reserve has committed itself to a huge increase in purchases of U.S. government bonds, mortgage bonds issued by Fannie Mae and Freddie Mac and lending to private investors to buy more bad bank debt. The Federal Reserve has an unlimited ability to lend because it can create more money. In the last six months the basic measure of money in the United States, or M-1, has grown at a 14.3% rate even as the economy has shrunk. But continuing to print money could also lead to a crisis in confidence in the U.S. economy and a falling dollar. Fears of inflation are also bound to rise, which would also lead to higher interest rates.

Despite the rush to embrace, or to damn, the growing federal budget deficit as a new ‘New Deal’ by some on the left or the right, the actual stimulus to the economy is small. When the financial market bailout and drop in tax revenues is taken out, the increase in the federal government spending on goods and services has only been about $130 billion over the last six months. Almost half of this increase in spending is offset by spending cuts and tax increases by state and local governments, leaving the net stimulus at only 1% of GDP.

The other problem with this increase in government spending (based on the ideas of Depression-era economist John Maynard Keynes) is that it does not deal with the huge overcapacity in auto, construction, retail, airlines and other industries. Keynesian government deficit spending only can address one side of the crisis of overproduction that the economy is going through, the shortfall in spending. It does not deal with the overbuilding done by the capitalists in their competition for more markets and greater profits.

The reality is that neither the New Deal nor even the military spending of World War II alone solved the crisis of overproduction of the Great Depression. The rebuilding of factories, machinery and buildings that decayed during the decade of depression, or that were destroyed during World War II, also laid the basis for the post-World War II economic growth. It is no coincidence that soon after the economies of Europe and Japan recovered from the war in the 1960s that a new crisis of recession and inflation hit the world capitalist economies in the 1970s.

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San José, CA – On Jan. 7, the Congressional Budget Office (CBO) estimated that the federal budget deficit for this fiscal year (October 2008 to September 2009) would be $1.2 trillion. But the CBO estimate only counted the $68 billion approved for the wars in Iraq and Afghanistan, when they actually cost more than $186 billion in 2008. Given that the wars will cost at least another $100 billion, the federal budget deficit will be $1.3 trillion, or even more if the economy worsens more than expected. This estimated deficit is almost 10% of the Gross Domestic Product (GDP), which measures the value of all the goods and services* produced in the United States in a year, and would be the biggest deficit since World War II.

In addition, the Obama administration’s economic stimulus package will cost $800 billion or more over the next two years. Assuming at least $300 billion will be spent this fiscal year, the total federal budget deficit will be about $1.6 trillion, or about 12% of GDP. Obama’s economic advisors released a report on Jan. 10 estimating that their economic stimulus plan could create more than 3.5 million jobs.

Republicans and conservative Democrats are starting to complain about the size of the deficit. However this is pure hypocrisy, as they helped to double the federal government debt, borrowing some $5 trillion under the Bush presidency. When the deficits went to tax cuts for the wealthy, the invasion and occupation of Afghanistan and Iraq, or lending to banks it was not an issue. But now that there is talk about spending money on the unemployed, helping homeowners and creating jobs, the deficit is all of sudden a ‘big concern.’

This is the real question facing the United States: Will all this government spending work? Mainstream economists from the conservative Martin Feldstein, who served the Reagan administration, to liberal Paul Krugman, who has been a fierce critic of the Bush administration, have backed a huge increase in federal government deficit spending to try to stem the recession. These economists are taking up the ideas of John Maynard Keynes. Keynes argued during the Great Depression of the 1930s that there could be a “liquidity trap” where banks refuse to lend. This would make the monetary policy of trying to lower interest rates ineffective. Keynes said that the government must borrow and spend to get the economy going again. The economy today is caught in a vise between a deepening recession and a growing financial crisis, just as in the 1930s. With the free market economics of the last 30 years buried under the collapse of big banks, many are calling for a Keynesian economic policy.

Following the economic crisis of the 1970s the United States turned to what was known as ‘Reaganomics’ – with tax cuts for the rich (and tax increases for the working class in the form of higher social security taxes), deregulation of industry (laying the basis for first the savings and loan crisis of the late 1980s and then today’s financial crisis), anti-union policies and the offshoring of jobs to other countries. This restored corporate profits and economic growth, as the rich grew richer and the poor grew poorer, while the working class and even many professionals went deeper and deeper into debt to make up for the lack of wage increases. Businesses and the government also went on a borrowing binge, driving total debt from 1.4 the size of GDP in 1977 to 2.25 times the size of GDP in 2007. This big increase in debt was led by the financial sector, whose debt has increased five times faster than the growth of the economy during this time.

This borrowing binge allowed workers to buy more when their wages saw little or no growth (adjusted for inflation). It also provided a profitable outlet for the extra profits that the capitalists were making. However it did not prevent a growing overcapacity, where industry can produce more cars, homes and other goods and services than can be sold. The financial crisis that exploded last year has led to ‘deleveraging’ of many households, who are cutting back on borrowing and starting to pay down their debts. Businesses are also borrowing less, while financial debt is declining sharply due to defaults on loans and banks refusing to lend. This has led to the worst crisis of overproduction since the Great Depression.

Only the federal government has stepped up borrowing, lending and spending to try to prevent the economy from going into free fall. The problem is that a capitalist economy cannot keep going forever based only on more federal government borrowing and spending. When the Japanese stock and real estate markets crashed in the 1990s, the result was years of economic stagnation. The Japanese government has run huge deficits (relative to the size of their economy) for many years since then. The problem in Japan was not the large size of the deficits, nor the resulting increase in government debt, but rather that the huge increase in government spending was not able to get the economy moving again. Even coupled with interest rates that have been less than one percent since 1995, the Japanese economy never was able to get back to steady economic growth. The only sector that had done well was exports, which are now falling due to the worldwide recession.

The United States is now following the same policy as in Japan. But if government deficit spending didn’t work in Japan, why should it work in the United States today? This is particularly true for the U.S. government, which has had to borrow 75-100% of past deficits from investors, insurance companies, pension funds and banks in other countries. In contrast, Japan has a higher savings rate, which makes their government able to borrow at home. At some point the rest of the world could cut back on purchases of U.S. government bonds, leading to higher interest rates and more economic pain in the United States. The only other option would be for the U.S. Federal Reserve to print more money to buy U.S. government bonds, putting the value of the U.S. dollar at risk and possibly leading to much higher inflation.

Many are comparing Obama’s economic stimulus with the Depression-era New Deal. The New Deal started many government programs that helped working people, such as Social Security, unemployment insurance and welfare. However it was not able to reduce unemployment back to pre-Depression levels. More government spending – for the unemployed, homeowners facing foreclosure and jobless workers – will help people, but won’t cure the economy. The economy faces a bleak future of continued high unemployment and/or the threat of higher inflation. Even the Obama economic team admits that with the economic stimulus, unemployment will remain above 7% for two more years! What is needed is an economy not based on private profit – a socialist system that would serve the interest of working people.

*GDP only counts final goods and services, for example the value of a book printed in the United States, and not the value of the paper that went into the book, or the trees that went into the paper, in order to avoid double and triple counting.

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