Gov't "net stimulus" rises again

What I call, "net stimulus," which I define as the daily amount of spending by the government, minus the amount of revenue it is taking in, is rising.

A positive reading indicates that the government is spending more than it is taking in, which is a good thing because by definition that is adding to the income and savigs of the private sector. Rising income and savings eventually equate to greater wealth of the private sector.

The graph below looks at a 5-day average of "net stimulus" superimposed against a chart of the S&P Index close. The way to use this is if net stimulus is falling or negative, you want to be defensive as a stock trader (sell into rallies) on the idea that the government's "wealth pump" is sucking wealth out.

On the other hand, if net stimulus is positive and rising, then you want to be bullish on stocks and buy dips, the idea being, the pump is pumping in income and savings and that will lead to greater wealth and higher stock prices.

The most powerful man in the world said, “The U.S. Government is out of money.”

A Dangerous Belief System At Work

One shocking example of how widespread this fallacy-ridden belief system has become can be seen in a statement made recently by President Obama, who claimed that the United States Government was, “out of money.” Such a claim is impossible for a nation that spends in its own, non-convertible, free-floating currency, but that did not stop the highest elected official in America and the most powerful man on earth from asserting that it was true!

read on...

Obama officials outline financial reforms

Every time I think they're about to blow it, royally, they come up with something good. I know that "free market fundamentalists," who nearly destroyed our economy, will be calling this the end of capitalism, however, I am not of the camp who things regulating a totally unregulated financial sector is a bad thing.

Some points I like:

Reduced reliance on credit-rating agencies will also be proposed, said the piece.

This is excellent news! Rating agencies have way too much influence and they are completely out-of-paradigm anyway, causing their pronouncements to be that much more destructive. There should be ZERO need for reliance on them, as far as I am concerned, but even if we get reduced reliance, that is a good thing.

"All derivative contracts will be subject to regulation, all derivatives dealers subject to supervision, and regulators will be empowered to enforce rules against manipulation and abuse," according to the op-ed piece.

Hopefully this will mean more oversight of speculative activity in sensitive materials, like oil and food. They didn't explicitly mention ending or putting limits on speculative activity or altogether banning pension funds and other passive, "long-only" investors from owning commodities, but at least this is a step in the right direction. Have you noticed how the clueless media is now calling the doubling in oil prices a "demand-driven" phenomenon? Yeah, demand for futures contracts. There's 13 million people out of work and the media's telling us that equates to more oil and gasoline demand?? It's speculation and it's the Saudis setting prices higher.

Here's how I feel (and I am just echoing the words of Warren Mosler, here):

Back in 1972, 2.6 million homes were built in this country and if you wanted a mortgage you went to your commercial bank for it. The bank originated the loan and serviced it. Bankers made salaries not much higher than civil servants and Americans bought homes, cars, appliances, took vacation trips and pretty much had and did all the things we have and do today.

Fast forward to 2006--the peak of the housing boom--and a time when the financial sector looked entirely different. Bank loans comprised only about 25% of all credit. Rather, credit flowed from unregulated intermediaries that dealt in risky, unstable, and hard to understand instruments.

Well, guess what? We built the same amount of homes (but our population is now 300 million, not 200 million like in '72), sold slightly more vehicles (whoopee!), but only used 80% of our industrial capacity compared to 86% back in the early 70's.

Why do we need the financial sector in its current form?

Answer: WE DON'T!!

Whether or not the Obama Administration understands that or not, I don't know. (Actually, I doubt it.) However, they are moving in the right direction.

"The financial sector is more trouble than it is worth." -Warren Mosler

P.S. Oh yeah, one more thing: In 2006 the financial sector earned 40% of all corporate profits in America, compared to single-digit percentages back in the 70's. That's way too much money to a sector that contributes nothing of real value to the economy. Get rid of it! Just keep the banks.

U.S. policy pushing China to economic supremacy. How you can profit...

I believe China now offers an unparalleled opportunity for investors who are interested in sustained and long-lasting investment returns that are likely to outperform markets in the U.S. and elsewhere.

What I see as the driving force behind the long-term bullish trend for the Chinese economy and stock markets are important policy shifts in the United States that are just now getting underway.

read on...

G-8 officials turn to IMF over stimulus withdrawal

Financial officials from the Group of Eight industrialized nations are expected to agree Saturday to ask the International Monetary Fund to investigate ways to unwind hefty stimulus packages amid early signs of a global economic recovery.

Can you believe this!!!! This is the endgame, right here. They will pull the stimulus because they are so ignorant and that will send us right back into another crash and deep economic recession.

And finance officials in the G-8 are so clueless that they are asking the IMF how to figure out how to essentially kill the global recovery. Of course the IMF will be happy to oblige and provide ways.

Invest in China!!!! They're not part of the G-8 and that country will be the next global economic superpower. It will happen rapidly now!!!

Fed to Keep Lid on Bond Buys

Reserves are functionally one-day Treasury securities, but the Fed doesn't seem to understand this and thinks that reserve balances drive inflation.

Nor does the Fed seem to understand that if it wants to target interest rates lower, it has the power, but that requires keeping reserve balances at a level that sustains the low rate. It is giving up on its rate target because of fear among certain FOMC members that this creates inflation?? Unreal!!

Japan has had zero or near-zero interest rates for 12 years and there is no inflation.

Does the Fed actually believe their inflation targeting efforts of the past two years was a success? Is it trying to do that again? My God, it's a big part of what created the housing collapse! By raising rates from 1% to 5.25% the Fed made it impossible for many people to stay in their homes. And did the Fed think that by doing that it was going to lead to more oil discoveries?

This destructive belief system is spiraling dangerously out of control.

How banks create money

China’s New Lending Doubles, Helping to Fuel Economic Recovery

Because they are not hindered by idiotic and inapplicable beliefs such as, "taxpayer on the hook." We are. Our beliefs ensure that China will soon overtake us as the world's number one economic superpower.

China's May trade plunges but investment up

If you STILL think stimulus doesn't work!

China's investment surged in May as the government poured money into its economic stimulus, helping to offset an unexpectedly sharp drop in trade, and economists said the world's third-largest economy was improving.

Spending on factories and other fixed assets soared 32.9 percent in the first five months of the year, the National Bureau of Statistics said. Merrill Lynch said that translated into growth in May of up to 38 percent.

"Domestic activity has picked up, thanks to the government stimulus spending," said economist David Cohen of Action Economics in Singapore.

Art Laffer on how banks lend money

In an otherwise terribly misleading and misinformed piece in the Wall Street Journal the other day, economist Arthur Laffer explained in an excellent fashion how banks create loans. Here it is below:

"The way a bank or the banking system makes new loans is conceptually pretty simple. Banks find an entity that they believe to be credit-worthy that also wants a loan, and in exchange for the new company’s IOU (i.e., loan) the bank opens up a checking account for the customer. For the bank’s sake, the hope is that the interest paid by the borrower more than makes up for the cost and risk of the loan."

So for anyone who still thinks that banks take your deposits and lend that money out or, lend their reserves, please re-read.

Furthermore, as bank credit comprises 90% of all of what we call the "money supply," if you still think that the Fed "prints money," let that go as well. Money is created in the banking system and the Fed only has marginal influence on that process insofar as it is the interest rate setter and, thus, the semi-regulator of bank profits, which should not be surprising because banks are agents of the Fed anyway.

Art's explanation of how loans are created also highlights another extremely important point, which is the fact that nearly all money emanates from a desire on the part of some private entity (an individual, a business) to issue and I.O.U. (a debt).

Thus, all "money" is really debt!

Gov't is the net supplier of savings

My email to Warren Mosler, detailing my macro outlook

Warren,

The good news is the deficit has already boosted non-governmentals savings to a record, $620 billion and that is only likely to grow larger by the time their spending reductions turn that trend. And of course, I = S, so we're in good shape for now.

Your original advice to me, when we had dinner in New York was, "Buy S&P futures and go play golf for a year." That was probably correct. I followed it. (Unfortunately, not in the size that I would have liked because of limited funds, but better than nothing. And, oh yeah, I am not a golfer, so I'm doing other things to keep me from watching stocks!)

Where I think you are wrong is China. I see China as having no choice in the matter. Even if they secretly desire to sustain exports they will have to relinquish this policy because it clashes with U.S. goals that now appear to be set in stone. It is becoming increasingly clear that the U.S. will not support a long-term commitment to sustaining output and employment if it means enlarging the "twin deficits." Moreover, policymakers on both sides of the aisle here in the States are terrified of the (inapplicable) fear that China will not keep buying our debt. They are also terrified of (clueless) rating agencies downgrading our AAA credit rating.

As such, there is a major long-term shift underway as I see it, where the U.S. comes to rely more heavily on an export-driven, "fiscally responsible" course that, by design, keeps income down and comparative advantage up (via a weaker currency vis-a-vis the renminbi at least). The Chinese will see a gradual, yet sustained erosion in exports to the America and, therefore, will be forced to rely on greater levels of domestic investment to support demand and employment whether they like it or now.

We are, in essence, handing them the mantle of global economic leadership because of our out-of-paradigm and destructive belief system. This is terrible for the citizens of this country and de-facto passes along to future generations of this nation a lower standard of living. But smart investors can "hedge" by investing in China now. China is where the U.S. was at the end of WWII, which means that fortunes will be made by those who buy and hold in what will be, as Boone Pickens likes to say, "the greatest transfer of wealth in the history of the world." (But he says it for the wrong reason!)

Other than that, everything's hunky dory!

-Mike

You think economic stimulus doesn't work?

Warren Mosler just emailed this to me.

China Car Sales Jump ‘Beyond Imagination,’ Bring Wait
China economy poised for 'sustainable' growth

China's consumer prices fall for 4th month

China Still Faces Net Capital Inflow Pressure, Market News Says
China’s Property Sales Surge, Add to Recovery Signs
China Should Prepare to Counter Stagflation, Researchers Say
China’s Industrial Output Climbed 8.9% in May, Ming Pao Says

Perfect record for Bloomberg journalists getting it wrong again!

This time it's Caroline Baum. Check out the piece she wrote entitled, ‘Legacy of Debt’ Gives Fiscal Stimulus Bad Name.

This is the email I sent her:

Are the current generation of Americans poorer than the generation who ran up the debt to fight WWII? That debt was far larger in proportion than the current debt, yet we are NOT poorer. Moreover, the top tax rate from 1946 to 1964 was 91%, then it dropped to 77%, which is still more than twice the current rate, yet the economy grew faster than it did following the Reagan tax cuts of the 1980s.

What you don't seem to understand is, to the extent that government spending adds to output and employment that leads to the creation of the real assets that will be used by future generations. That is known as wealth! This is precisely why our grandparents' "legacy of debt" did not bring us down to a lower standard of living.

Yours is just another example of misinformed journalism, which serves only to propagate economic myth and fallacy. That is the real danger to our heirs.

-Mike Norman

Gov't doesn't need its TARP money back!

Treasury "net spending" slowing down

The blue line on the chart above shows the 5-day average of total Treasury deposits (recepits) minus withdrawals (expenditures), something that I call, "net spending." A declining blue line indicates that net spending is falling. Not only has it been falling, but it has been running negative for nearly the past three weeks, suggesting that deficit hawks at Treasury are firmly in control and are quietly "siphoning off" stimulus and private savings (taking in more than they are recycling back).

The pink line is the S&P 500 close. A policy of negative net spending will make it harder for the stock market and the economy to rise and improve, respectively. That's not to say they can't (there are record private savings of $620 billion, so plenty of fuel to run on), however, it will take a sustained upward trend in confidence. The government is quietly shifting the burden of recovery to the private sector because of sensitivity over deficits. It can work because as I said there are sufficient private savings to power it, however, as I said, the rally now has limits by definition.

Obama, facing high unemployment, defends stimulus

This is good news for the markets and investors. Obama, facing pressure that job creation is not happening, is (hopefully) shelving spending cut plans for now in favor of stimulating the economy further. He needs to see job creation or his approval ratings and political "capital" will erode.

Roubini Scoffs at Green Shoots, Sees Dangerous Complacency

Roubini is the worst kind of ideologue. Most ideologues will just stick to their guns even if that ideology is caving in around them. They will rationalize a million different reasons why the truth is not the truth. This makes them easy to spot...and avoid!

But guys like Roubini are more dangerous because they'll attempt to "go the other way" from time to time to make it look as if they really care about those whom they are advising. They'll say, "Things are starting to get better" or, "Now's the time to get back in the market," even though they are loathe to admit it. Any advice they give you that runs against their belief system (which, in the case of Roubini is an extreme, anti-America bias) is just plain, phony. And worst of all, they'll revert back to their bearish views in an instant, proclaiming that they never really were bullish in the first place.

This flip-flopping not only kills people who are following their advice, it also lends a false air of maturity and wisdom to their advice when in fact there is none.

Be wary of these chameleons. They can inflct lots of damage on unsuspecting investors who choose to follow their ideologies and listen to their dogma.

The dollar is soaring!

Up to 98 vs. yen
Up to 1.4 vs. euro

Here lies the fallacy that stimulus is bad for the dollar!

If stimulus results in an improvement in the labor market, that should be good for the dollar and it is!

Those who say stimulus is bad for the dollar WANT to be BEARISH on the dollar all the time, no matter what!

Dollar bears are ideologues. They don't understand the monetary system! They WANT to be BEARISH on the dollar no matter what the facts are!


Dollar bears don't understand...

Dollar bears don't understand ouble entry accounting.
Dollar bears don't understand for every debit there is a credit.
Dollar bears don't understand for every liability there is an asset.
Dollar bears don't understand for every borrrower there is a saver.
Dollar bears don't understand for every dollar of the trade deficit there is a dollar of capital account surplus.

This is the beginning of what could be a secular advance in the dollar. If I am right, gold is going down significantly.

Gold at $400, anyone?

The benefits of not having to explain things to Congress

(Thanks to Warren Mosler for pointing out the ECB story!)

The philosopher Thomas Hobbes once said that societies are a natural consequence of man's desire to avoid life in the "jungle state." (Hobbes defined jungle state as a constant state of war.)

In other words, human beings give up some of their freedoms to exist under some authority in order to ensure security, establish the rule of law and to avoid a constant state of warfare.

He also said that "assemblies" (like Congress) are destabilizing and ultimately fail and rule eventually goes to a single authority. (A monarchy, for example.)

In the realm of economics we have a microcosm of Hobbes' theory when it comes to the behavior and pronouncements of central banks.

In one corner we have the Federal Reserve, which has to answer to Congress.

The Fed has been under pressure to "explain" its actions recently and as a result of this scrutiny, by many members of Congress who know absolutely nothing, operationally, about the Fed, Bernanke and other Fed officials have used some pretty bizarre language. They use the term "printing money" to appease the views of the uniformed. They struggle to explain their "exit strategy" out of fear that Congressional leaders will deem it inadqueate or otherwise ineffective. They talk about deficits raising interest rates when they know full well that the Fed sets interest rates and could keep them at zero for as long as it wanted.

We see that most of the time the "Fedspeak" is about placating Congress. (Alan Greenspan was a master at saying nothing, but getting Congress to agree. He coined the term. A veritable Einstein!!)

In the other corner we have the ECB, which is totally independent and does not have to answer to any political body and certainly not to an idiot-laden assembly like Congress.

Look at how simply and eloquently Jean Claude Trichet spoke about the ECB's "exit strategy" for what he called, recent, non-conventional measures. (Quantitative easing.)

By concentrating its non-standard policy measures on the supply of unlimited liquidity to banks, the ECB has ensured it has “an in-built exit strategy,” Trichet said in a speech in Warsaw today. “That is, when tensions in financial markets ease, banks will automatically seek less credit from the ECB. This will be a decisive element in ensuring a non-inflationary recovery.”

Essentially, what Trichet says is that the private sector itself will be the determinant as to when and by how much the policy is reduced. The ECB just plays a passive role and the whole thing fixes itself.

He is absolutely right!

Now, can you imagine the outcry in the U.S. Congress and in the American media if Bernanke said that? If he said, "We'll just let the banking system decide when enough is enough."

Congress would go nuts! The know-nothing media would go nuts! Dick Morris would go nuts!

Yet, it's EXACTLY what the Fed has been doing and it's EXACTLY why the Fed's balance sheet topped out six months ago.

Has there been any mention of the latter in the media? No! Only lawsuits by the news organizations against the Fed!!

And most Americans accept this because just going along with it is a lot easier than putting in the effort to learn the truth and the facts.

Pimco's Gross: Maybe Obama Should RAISE Taxes

Comments on this article from Warren Mosler (below):

RAISE TAXES WITH UNEMPLOYMENT RISING DUE TO A SHORTAGE IN AGGREGATE DEMAND?

JUST IN CASE YOU THOUGHT THE GREAT MARKETER UNDERSTOOD THE MONETARY SYSTEM!!

(Warren calls Bill Gross "The Great Marketer." A well-deserved moniker due to the success, in size, of his Pimco fund and to his high standing in the media.)

I had Gross on my radio show once and he did not understand the distinction between a sovereign, currency-issuing nation and an individual or a family in terms of finance. He equated them as the same.

AP source: GM studying more temporary shutdowns

If you need a new car you'd better go buy one now! If you want to make money as a speculator forget gold and oil and foreign exchange, go buy some cheap, used cars and park them in your garage. In six months or a little more you'll be selling those cars for three times what you paid for them.

This is all going to happen because of the terribly destructive "solution" to what "ails" the U.S. auto industry. Forced downsizing of an industry that produces some of the most necessary real assets in a growing population (a growing world population) is just, plain, stupid.

The fact that the Administration is also doing this at a time when the industry itself has cut back significantly on production shows how ignorant they are of economic reality and how deeply they are held by a destructive belief system. ("Taxpayer on the hook.")

More than anything the Fed has done in setting interest rates (raising the level of reserves in the banking system), the destruction or elimination of productive capacity in key industries that supply some of the most important real assets to our economy ensures: a)lower productivity in the future, b) higher real inflation in the future, c) a lower standard of living in the future.

This is the real way that taxpayers will be put "on the hook."

Sustaining GM and Chrysler (and the jobs of the workers who labored for them) at the bottom of an economic cycle at a time when the government itself was working hard to buoy the economy would have made all the sense in the world. That's precisely why it didn't happen!

Goldman Raises Year-End Crude Forecast by 31% to $85

Yes, and Goldman will be one of the big reason it gets there, or higher, as it buys futures for its own account and pushes speculative behavior on the part of its clients. Nothing has changed. The financial crisis taught our policy makers nothing. Oil prices will have to go much higher before evoking a political response.

Bernanke: start work now to curb US budget deficit

Does Bernanke believe that non-governmental (private sector) savings are too high? Wasn't he complaining a couple of years ago that they were too low and we were too dependent on "foreign savings??"

Well, saying, "The government should start to curb the deficit," is the EXACT same thing as saying that the government should take away private sector savings, because that's what it is!

Whatever's on the government side of the ledger is the equal-but-opposite on the private sector side. The fact that Bernanke doesn't realize this is astonishing!

(Go see my chart a few posts back.)

GOVERNMENT DEFICITS ADD TO PRIVATE SECTOR SAVINGS!
ONLY GOV'T CAN BE A NET SUPPLIER OF SAVIGS!

I hope you enjoyed this market rally over the past three months because if the Administration follows Bernanke's advice--and it's likely that they will-kiss the rally goodbye and say, "Hello," to new lows in the market sometime later this year or next year.

Bernanke warns on deficits as Treasury rates rise: Part II

Bernanke also doesn't seem to understand that it is the Fed that sets interest rates! How amazing is this???

If Bernanke wanted the long bond yield at zero, tomorrow, it would be a done deal. He just needs to understand that.

Under its authority the Fed has unlimited ability to credit reserve accounts in the banking system. In other words, it has unlimited ability to buy--Treasuries, mortgage backed securities, stocks, anything.

So bringing rates down is not only a "no-brainer" for the Fed or any other central bank of a government that issues non-convertible free-floating currency, it is what central banks do, naturally.

In contrast, raising rates is a lot tougher for the Fed because it needs something to sell and it doesn't issue its own securities. (Although that is currently under consideration.)

That's why central banks usually like when rates are rising on their own, as long as economic conditions are stable or improving.

Bernanke warns on deficits as Treasury rates rise

"Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance," Bernanke said in testimony prepared for delivery to the House of Representatives' Budget Committee.

"Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth," he said.

Add Bernanke to the list of people who don't understand our monetary system.

This is truly amazing when you think about it!

Rather than expressing concern as to whether or not the nation is fully utilizing its resources and capital (both physical capital and human capital) to maximize wealth and prosperity (basic microeconomics here, folks!), Bernanke gets all wrapped up in the nominal level of debt.

There is no mention of the fact that for every liability (debt) there is an asset (credit) and for every borrower there is a saver. That's only an accounting principle that has been in practice for 500 years!

Nor is there any understanding that most credit is created in the private sector to facilitate the consumption of goods and services--the very thing that defines the economy--and if the growth in credit is slower than the overall accumulation of the real assets that we need to live, then by definition we have rising prosperity. We are getting rich!

To the extent that gov't debt both adds to private sector savings (by definition, again!) and fosters a trend toward the full utilization of the nation's capital, but not beyond, then there is absolutely nothing to worry about. In fact, it is something to cheer.

We're dead with the likes of Bernanke's stinkin' thinkin'.

Irrefutable: Gov't deficits add to private savings

How can anyone sit here and say that this isn't true?? This chart shows unequivocally how record deficits have created record private savings. This is absolutely irrefutable. Our leaders and academics are operating under a completely irrational belief system.

Send this graph to your Congressional representative today!!!

Gov't transfer payments added over $250 billion to personal income in the past year!

Our leaders and some of the most educated academics still say that government spending absorbs private savings despite "black and white," absolute, unequivocal proof that the opposite is true.

In today's personal income report the numbers were starkly clear: Government transfer payments (for Social Security, disability, medicare, medicaid and unemployment insurance) added $254 billion to personal income in the past year. In contrast, private wages and salaries DECLINED by $154 billion!

And personal savings in April reached a record of $620 billion!

Only government can be a net supplier of savings!!!

How can our leaders be so blind to the truth?? This nation's belief system is killing us!!

Some thoughts

Just some thoughts I had this morning...

If we ever enact a balanced budget amendment, take yourself and your family and move to Canada or China.

Obama believes the U.S. has "run out of money." Scary. Our president doesn't understand our own monetary system. Even George Bush understood this.

Any country that spends in its own currency, where that currency is not backed by gold or bound by some fixed exchange can NEVER run out of money!

We are ceding our position as the world's largest economy to China because of stupid policies that are based on myth and fallacy.

The demise of GM was not due to putting workers' interests over the company and shareholders. It was precisely the opposite!

The easiest way to lower "debt" (if that's what you want to do) is to sustain full output and employment.

If the private sector can't sustain full output and employment for whatever reason, then gov't should!

Here in America we mock the Europeans as being, "socialist." Did anyone notice that Europe's economy is larger than ours and adding size?

By definition, those Socialist Europeans are richer than us! And they have free health care, education, 6-weeks paid vacations, new cars, movies, theater, culture and all the consumer items that we have. Not bad for a bunch of commies!

Our leadership is destroying America's real terms of trade because of irrational sensitivity to perceived "imbalances."

We care more about the Chinese standard of living than our own, apparently!

For every debit there is a credit. For every liability there is an asset. For every borrower there is a saver. This is all definitional. It's double entry accounting! Did anyone in Obama's administration take an accounting course? Has any Republican taken one? Has any Democrat taken one?

We could be next!

Over the weekend the German parliament voted in something quite close to a balanced budget amendment. Germany is constrained in its ability to deficit spend because by adopting the euro is has functionally become like a state within the United States and can only spend by having savings on hand first.

Nations that issue their own currency that is not backed by gold or bound to some fixed exchange rate do not have this problem. Spending is merely a keystroke on a computer.

However, don't expect lawmakers in the United States to understand that distinction. The risk that we see something similar here--a balanced budget amendment--is growing rapidly. If that happens, take your family and move to Canada or China. Jim Rogers may have gotten that one (the move) completely right!

Read article below:

Berlin vote heralds big spending cuts By Bertrand Benoit in Berlin Published: May 29 2009 14:00 Last updated: May 29 2009 18:50 The next German government is almost certain to crack down on spending and drastically raise taxes after the lower house of parliament yesterday adopted measures that come close to banning budget deficits beyond 2016. The controversial constitutional amendment, part of a reform of federal institutions, will prohibit Germany’s 16 regional governments from running fiscal deficits and limit the structural deficit of the federal government to 0.35 per cent of gross domestic product. The amendment still requires approval by a two-thirds majority of the upper house of parliament which represents the regions. The vote is scheduled to take place on July 12 and is expected to be approved. The most sweeping reform of public finances in 40 years was an “economic policy decision of historic proportions”, Peer Steinbrück, finance minister, told parliament shortly before MPs endorsed the amendment with the required two-thirds majority. The vote underlines Berlin’s determination quickly to plug the holes that the economic crisis, two fiscal stimulus packages and a €500bn ($706bn, £437bn) rescue operation for German banks are expected to blow in the public coffers this year and next. In 2009 alone, legislators from the ruling coalition expect the federal budget to show a deficit of more than €80bn, twice the current all-time record of €40bn reached in 1996 as Germany was absorbing the formidable costs of its reunification. This figure does not include the deficit of the social security system, which is expected to rocket too, as unemployment rises to an expected 5m next year. The constitutional amendment, popularly known as the “debt brake”, allows a degree of flexibility in tough economic times, just as it encourages governments to build cash reserves in good times. Yet economists have warned the new rules could force the next government to implement a ruthless fiscal crackdown as soon as it takes office after the general election of September 27 if it is serous about hitting the 2016 deficit target. “Given the massive fiscal expansion we are currently seeing, the ‘debt brake’ will lead to a significant tightening of fiscal policy in the coming years,” Dirk Schumacher, economist at Goldman Sachs, wrote in a note. In a separate assessment, the Cologne-based IfW economic institute said the federal government would need to save €10bn a year until 2015 through a mixture of tax rises and spending cuts. Klaus Zimmermann, president of the DIW economic institute in Berlin, said the next government might have to increase value added tax by six points to 25 per cent. This would be the biggest tax rise in German history. The “debt brake” could complicate Angela Merkel’s re-election bid. Under pressure from parts of her Christian Democratic Union, the chancellor recently pledged to cut taxes if returned to office in September, though she pointedly failed to put a date on her promise. The Free Democratic party, the CDU’s traditional ally, has made hefty income tax cuts a key condition for forming a coalition with Ms Merkel’s party should the two jointly obtain more than 50 per cent of the votes. The debate has cut a deep rift within the CDU, which was threatening to deepen further yesterday as opponents of tax cuts seized on the constitutional change to back their arguments. Günther Oettinger, the CDU state premier of Baden Wurttemberg, said “promises of broad tax cuts are unrealistic… First we must overcome the crisis, then we need more robust growth, and when we finally get more tax revenues, we should use them to repay debt, finance core state activities and for limited, very targeted tax cuts.”