I have covered many
times why I am against austerity at the present moment. In fact, it was one
of my big risks to economy and market going forward.
The problem with the fiscal cliff and the austerity it will
bring – the same problem Ben Bernanke speaks of – is that what picks up that
slack? If GDP is comprised of
consumption + investment + net exports + government spending and government
spending is cut, which one of the other 3 is going to increase to offset that?
I don’t model GDP, but the bullets below should give you
an idea of the growth versus austerity trade off:
- The Congressional Budget Office reckons that the combined effects of the “sequester” and the expiring tax cuts would add up to 3.6% of GDP in fiscal 2013. (Source 3)
- David Greenlaw of Morgan Stanley, which puts the total effect at almost $700 billion at an annual rate, argues that the calendar-year impact is at around 5% of GDP. (Source 3)
- David Rosenberg estimates the drag equates to roughly 4% of GDP from reduction of those tax benefits to spending. (Source 1)
- According to Goldman Sachs, the total of amount of dollars the US government will be taking out of the economy is about $600 billion. (Source 2)
Such reductions have happened in the past, but with poor
results:
- The last two times, 1960 and 1969, that there was a fiscal retrenchment of the same magnitude both ended in recessions. (Source 1)
- In 1968, when individual, corporate, excise and payroll taxes collectively rose by the equivalent of 3.1% of GDP, mostly to pay for the Vietnam War and to damp down inflation. The next year, the economy fell into recession. (Source 3)
Now, the flip side would argue that at least we will reduce
the budget deficit, but who cares? At
the expense of growth this seems silly.
Further:
- Austerity hasn’t worked for Europe. Take a look at Spain, where austerity is taking place. There GDP is falling and unemployment is at 24% and rising. Further, the benefits austerity should have brought aren’t happening as bond yields are increasing and the deficit is growing.
- Why do we need to cut the deficit now? Interest rates are low, very low, inflation is tame, and GDP growth is still sluggish. What exactly is the risk at the present moment?
In the last post I will discuss the probabilities of what
will ultimately happen with the “fiscal cliff”.
Source 1 – Lance Roberts and David Rosenberg.
Source 2 – Walter Kurtz and Goldman Sachs.
Source 3 – The Economist.
