Get ready for the deficit to balloon. One of the commonalities of banking crises that Ken Rogoff mentions in his research is a rapidly rising deficit. It turns out that the deficit arises not so much from increased government stimulus spending as it does from a rapid loss of tax revenue. This Wall Street Journal article discusses the problem on a state level. If you scroll down to the graphic, you can really see how rapidly tax revenue has fallen away.
This phenomenon will not be confined to state governments; the federal government will have the same problem. What will the effect of large deficit spending on the U.S. dollar? Will federal borrowing crowd out corporate borrowers? How will it impact expectations for the economy and the stock market?
The truth is that no one knows how it will all play out. Every economic systems has so many intricate, unseen linkages and so many variables that if a forecaster gets it right, it will simply be lucky. We can see the inputs, but we can only guess at the outcome. It might be wise, however, with so many unknowns to adopt a more flexible tactical approach to assets.
