Yesterday I wrote that most of Europe is now talking about reducing deficits rather than adding stimulus. Now it appears that the U.S. is going in the same direction.
It's not that I'm not concerned about deficits - we obviously have to make some serious changes in government spending - but at this point I'm not convinced that the economic recovery is strong enough to deal with a large dose of higher taxes and lower spending.
If you think about the arithmetic from Econ 101, our GDP is calculated as follows:
GDP = C + I + G + X
where C is consumption spending; I is investment; G is government spending; and X is net exports.
The consumer is spending again, but only cautiously. Continued continued growth in by consumers will in large part be determined by jobs and the housing market. Unemployment remains stubbornly high, and even the most optimistic forecasts don't look for the jobless rate to decline significantly by year-end, at least.
Housing, as Paul Volcker said recently, remains totally a ward of the state. In other words, the mortgage market is being totally driven by government policies, and the Fed, at least, is pulling back on its activities in this area.
In short, I think the outlook for the consumer is probably muted for a while. And consumer spending represents 2/3 of our GDP.
Turning to investment, there still seems to be too much excess capacity to see much of a significant boost in cap ex. Moreover, it seems that more spending on new projects is occurring in lower wage cost markets, e.g. China or India. So not much help there.
Our export market will definitely be hit by the strength of the dollar, particularly against the euro. Moreover, most government policies around the world seem to be focused on "beggar thy neighbor" ideas, where internal growth is spurring by more exporting.
Which leads to government policies. If government spending is cut, or at least its growth reduced, I would argue this would remove a major source of growth. Again, I understand the argument that we need to do something about deficits, but I worry that this is not the time to do so.
There is a precedent, which is often referred to in the financial press. In 1937, government spending created a spur to the US economy, and things seemed to be getting better. By 1938, attention turned to reducing government spending and tightening credit. When this happened, the fledgling economic recovery was snuffed out, and the economy and employment plunged again. Only with the onset of World War II did the US begin to grow again.
Also, as I have said repeatedly, all of this talk of reducing government spending will eventually lead to more deflationary pressures.
Here's an excerpt:
The box that Europe, the Obama administration and Congress find themselves in today — desperate to stimulate the economy and fearful of the political reaction — gives new meaning to Milton Friedman’s famous line from the mid-1960s. “In one sense, we are all Keynesians now,” he wrote to Time magazine, referring to the theories of John Maynard Keynes, who called for government spending to counter downward cycles in the economy. In a less-remembered continuation of that sentence, he added, “in another, nobody is any longer a Keynesian.”
Today they are periodic Keynesians. The Senate has taken up a jobs bill that could cost $100 billion over the next decade, a fraction of last year’s historic stimulus package, but significant by the standards of other such jobs packages over the last two decades. “Here in the Senate, jobs will remain priority No. 1,” Senator Charles E. Schumer, a Democrat of New York, said Tuesday. “It’ll be almost an obsession to us.”
Not surprisingly, the parties cannot agree on the best path to satisfy their obsessions.
Calls for Stimulus Yield to Deficit Concerns - NYTimes.com
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