A Rational Look at Current Economic Prospects

By Liberty Works Contributor Drew*
Boomerjeff, proprietor of Liberty Works, has done a fine job pointing out the difference between the Administration’s promises – especially regarding employment – and economic reality.  Frequent commenters (trolls, really) drop by with lightweight criticism.   But for serious people who visit this blogsite, I thought a sober review of certain facts, constraints and potential economic outcomes might be in order at this time.  The charts are taken from various sources.  Some of the text comes via commentator John Mauldin, however the views put forth are mine.

Boundary Conditions
As any good engineer will tell you, the first thing you do in analyzing a problem is look at its possible limits: its boundary conditions.  Then you look at possible scenarios within those conditions.  And the first of those is the US’s borrowing constraint: How much can we borrow?   If you were unhappy with spending and borrowing under the Bush Administration, take a look at the Obama Administration!!  Even under their rosy scenario they make the Bush Administration look like absolute misers.  And what is the constraint?
image001

We simply cannot borrow $15 trillion in the next ten years. Not at anywhere near the low interest rates the government enjoys today.  (Note that the chart above was created before the health-care reform bill. Add at least another trillion to the total. Anyone who thinks that bill will reduce the deficit is kidding themselves.)

This does not bode well.

So What Does It Mean?
Simple.  We have two paths to choose from. We can either slowly bring the US budget deficit back into balance (or at least the rate of increase to less than the growth in nominal GDP) or we can continue on the current path and become Greece or Japan.

The first choice is a bad one, but the latter choice would be disastrous. If we take the first choice, a meaningful reduction would have to be on the order of $200-250 billion a year. That, along with reduced spending by state and local governments could amount to reducing spending by a little more than 2% of GDP.

We all recall (well, some of us) the basic equation GDP:

GDP = C + I + G + E

  • C: Consumer and business spending
  • I: investments
  • G: government spending
  • E: net exports

But the borrowing constraint tells us that the US government borrowing and spending binge can’t continue.  This will be a drag on GDP.  There is no way around it. That means that if inflation is 2% and we have a reduction in “G” of 2% of GDP, then the nominal growth in GDP will have to be 6% in order to achieve after-inflation growth of 2%. Not likely.

Those who would point to the 4th quarter stat of 5.6% GDP growth need to sober up.  The growth was largely statistical. First, Part of it came from inventory accounting, as inventories had gotten as low as they could go, the increase in inventories temporarily boosted GDP.   But this is not sustainable.  Second, a significant portion of the increase in GDP came from the stimulus. As noted above, an increase in “G” will be reflected in current GDP.  This stimulus begins to go away in the second half of the year, and there is little reason to believe there will be more “stimulus” other than more extensions of unemployment benefits after that.

So what does it all mean?  Probably a slowing, though still positive, economy and unemployment closer to 10% than 9% at the end of the year.

But Wasn’t There Good News on Unemployment?

Only marginally.  Employment rose by 162,000 jobs last month, with about 48,000 of those being census workers and another 82,000 coming from the birth/death ratio, a statistical method of guessing how many new businesses are started and adjusting total employment accordingly.  Said another way, employment growht really was anemic.

Small businesses may (and I say may) have at least stopped laying people off.  But they haven’t started new hiring, and they account for about 40% of all job creation. As a small business owner (6 businesses) and someone who speaks with small business owners all the time I can tell you definitively that small business owners are frozen into inaction right now due to the anti-business climate, looming tax increases and worry over the costs of the health care bill. Look at the chart.  The change is zero.image002

So what are the longer term prospects for employment?  The rosiest scenarios predict unemployment above 8% in four years.   Even that assumes a another 1.3 million new jobs can be created this year, plus  two million more every year thereafter, with no recession. Good luck with that. Take a look at this graph.image003


A whopping 398,000 people were added to the civilian labor force in March (a huge number when compared to the 162,000 new jobs – a discrepancy you conveniently didn’t read about in any report.)  One would expect the unemployment rate to increase, since the labor force grew by more than double the number of new jobs.  But, the bean-counters deducted from the labor force 238,000 people who are no longer counted as “unemployed,” because they have given up looking for jobs.

The U-6 unemployment rate rose to 16.0%. The U-6 rate includes people who have part-time work but wish they had full-time work. That part-time number rose above 9 million again this month, in a rather large monthly jump.  Now THAT’s ugly.

How About Balancing the Budget With Tax Increases?
Basically, tax increases have a negative impact on GDP of three times the size of the tax increase. And you don’t have to believe me (trolls), go search for the research work done by none other than Christina Romer, head of Obama’s Joint Council of Economic Advisors, and co-author with her husband of the research.  She says so.

So think about it.  As it is, taxes may be going up by as much as 2% of GDP in 2011, when you include state and local increases. This could be as much as a 6% drag on GDP over the next three years.  Can you imagine the effect of further increases in an attempt to bring tax revenue in balance with Obama’s enormous spending plans?

Let’s add it up. We will likely see a reduction in government spending (from all levels) over the next few years, a really nasty set of tax increases, which will hit small business employers the hardest, andcontinued high unemployment, and all from an economy that will be weakening by the end of this year.

All these factors increase the odds of a double-dip recession in 2011.  Its not a sure thing.  Maybe sane voices will emerge and the tax increases will phase in over 3-4 years. Also, the American economy and businesses are generally more resilient than we think.

Let’s try to sum it up. We slog through this year; (not much more than 2% overall growth for the year), with a slowing economy next year. Unemployment stays high. If we get our deficits under control, we lock in a slow-growth economy for 5-6 years.  A recession puts that brighter outlook out a little farther. Unemployment would go north of 12%.

Alternatively, we do not get our deficits under control. We can go on borrowing for awhile.  But you can’t solve a debt crisis with more debt. Ask Greece.  Things go along until there is a loss of confidence in the bond market, and then all hell breaks loose. When is that? Who knows? But it is not ten years away, and probably not five. Rates skyrocket and the currency takes a hit.

And then we are presented with a conundrum. Would the Fed really enable the government to run huge deficits by monetizing the debt? It would be a crisis decision. If they just stand by, interest rates soar and the economy goes into recession or worse.  Or, if they print money to repay government’s debt, we could see inflation and a crashing dollar, with interest rates soaring. This would be a disastrous scenario.

If you think the politicians cannot muster the will – or there are enough trolls out there drinking the cool-aid – to make the cuts, then bet on the disaster scenario.

And a final note:  This wild spending and borrowing binge hasn’t been and won’t be under President Bush’s watch.  The tax increases won’t be under Bush’s watch.  The monstrously expensive health care plan wasn’t hyped and enacted under Bush’s watch.

Barack Obama owns all of it.

*Liberty Works Contributor Drew is a Partner in a middle market private equity fund dedicated to investing in, nurturing and advancing the great American ideals of entrepreneurship.  He toils daily in the world of  financing, acquisition and management of small and medium sized manufacturing businesses.

5 Comments so far

  1. Thousand Flowers Blooming on April 8th, 2010

    As expected, this blogsite cant let stand the good news the the stimulus and other administration policies are finally beginning to show some positive results. You just can’t stand it that your failed neo-con free market policies that led us into this disaster have been repudiated.

    Well nobody’s paying any attention. This is the change we voted for and were glad it is finally starting to happen.

  2. Sarah Livingston on April 8th, 2010

    Thousand flowers…

    Who will pay off the Trillions in new debt? The toot fairy?

    This is like a family living off visa cards until suddenly one day, they realize they can’t climb out of the hole they spent themselves into.

  3. Sarah Livingston on April 8th, 2010

    Drew…

    I think I understand how they could monetize the debt. But it wouldnt work unless they stop borrowing would it?

    I know its bad but it looks like the only way out. Is it?

  4. Drew on April 8th, 2010

    sarah –

    Yes, they could attempt to monetize the debt. However, with everyone (that is, those financing the debt) looking out for this policy option the effect on interest rates and then the value of the dollar would be disastrous.

    It would precipitate a crisis. Did you see the treasury auction results?? Buyers are already becoming fed up with the spendthrift ways of this administration.

  5. Drew on April 9th, 2010

    Sarah –

    I realized I didn’t give you a complete answer.

    I can see only one way to get through this budget mess, a combination of: 1) “bending down” the spending rate to less than GDP growth so that we can grow (and I mean slowly, over a decade) out of it, 2) unfortunately, modest increases in taxes, but [probably not phased in until 2011 and 2012), and 3) something like means testing of entitlements, or, say, an increase in the SS retirement age.

    The problem with that prescription? I see no evidence of an Administration or Congress willing to do the politically unpopular things wrt spending. In fact, its just the opposite. The ideological fervor of the Obamaites will probably bring on GDP choking tax increases too soon. Under my scwenario, we might work out of the mess in a decade, and have 5-6 years of 1-2% GDP growth. I call it muddling through. Under what I fear will happen I see a potential double dip recession, followed by chronic unemployment in the teens, and a currency devaluation.

    After all, there is a constituency out there who thinks things are going fine. Look at TF’s response. Did you see one scintilla of intellectual content in it? No, just ape-ish cheerleading.

    Its a droll read, but a website called “zerohedge” chronicles the state of national and internation debt issues on a daily basis.