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Experts See Deficit Growing by $9 Trillion

By Michael Kling   |   Tuesday, 03 Feb 2009 04:04 PM

The federal deficit will grow by another $8 trillion or $9 trillion. Unemployment will reach the double digits, and home prices won’t bottom out before 2010, predict two leading economists in The Wall Street Journal.

They base their predictions on past financial crisis in other countries: Spain in 1977, Norway in 1987, Finland in 1991, Sweden in 1991, and Japan in 1992.

“When one compares the U.S. crisis to serious financial crises in developed countries, or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning,” write professors Carmen M. Reinhart of the University of Maryland and Kenneth S. Rogoff of Harvard.

Central government debt typically increases 85 percent in the three years following banking crises, and not because of bailouts but from a drop in tax revenues.

“Aggressive countercyclical fiscal policies also play a role, as we are about to witness in spades here in the U.S.,” they write, citing the humungous stimulus plan.

With the national debt almost doubling, expect much higher interest rates and a collapse of the bond-market bubble, they say. That could also mean anemic economic growth for another five to seven years.

In financial calamities, inflation-adjusted housing prices typically drop 36 percent, and peak to troughs run five or six years. That means housing, which peaked at the end of 2005, will reach bottom in 2011 or 2012 and that prices will fall another 8 or 10 percent from current levels.

Since unemployment rose for five years on average in past crises, the economists believe U.S unemployment now will reach double digits. Currently, U.S. unemployment stands at 7.2 percent.

The government must let financial institutions be restructured through bankruptcies before recapitalizing them, they argue.

“This is not the time for the U.S. to avoid painful but necessary restructuring by telling ourselves we are different from everyone else.”

Paul Krugman, a Princeton economics professor and Nobel Prize winner, compares the current situation to the Great Depression. The economy is descending into a deflationary spiral, with falling prices and demand, he said at lecture in Portland, Ore., last week.

“We really are in a kind of Alice in Wonderland economic landscape,” he said. “It’s going to be a very tense, nail-biting not just a few months but a few years as we struggle to work our way out of this.”

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The federal deficit will grow by another $8 trillion or $9 trillion. Unemployment will reach the double digits, and home prices won’t bottom out before 2010, predict two leading economists in The Wall Street Journal. They base their predictions on past financial crisis in...
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