Double Dip Recession and the Obama 2011 Budget

This past Monday I was on the BBC talking about the recently unveiled Fiscal Year 2011 Budget proposed by the Obama Administration for the U.S. Federal Government.  The budget is, as with most things Obama, a tightrope walk between the two ends of the political spectrum.  On the one hand, the President wants to be perceived as concerned about deficit spending.  But, on the other hand, he also wants make sure any budget he proposes is supportive of near-term economic growth. His budget is reflective of these competing interests.

As a result, it falls flat – and is likely to please no one.  In my view, this makes the President and his party beholden to the economy. If the measures already in place are supportive of recovery, this budget is irrelevantregarding the near-term. However, if the economic fragility we now see on display becomes worse, Obama will suffer greatly.

In the video below I discuss Obama’s tightrope walk and what it means for his political fortunes.

What I didn’t say in the video is that I believe the U.S. economy is more fragile than policy makers would have us believe. In particular, I see rising jobless claims, anaemic hiring trends and looming state budget cuts as headwinds which will have a lot of implications by mid-year.

Moreover, just as the Federal Reserve has signalled an end to its purchases of mortgage backed securities, we are now beginning to see the signs of a second but larger wave of Alt-A and Prime mortgage defaults, many of them strategic. These are mortgage cohorts which are an order of magnitude larger than subprime. The concomitant pressure on asset prices will be very negative for bank balance sheets and credit availability.

On the other hand, while I worried that the inventory cycle was not predicated on new order growth six months ago, we do appear to be firing on all cylinders in the manufacturing sector now. We have been in a technical recovery since late Summer 2009 in my view.  However, when all is said in done, I believe we will see that GDP is now rising mostly as a result of stimulus and inventory builds. Stripping inventory alone out of Q4 2009 GDP gets you down to a less than stellar 2.3%. Unless we see companies poised to hire en masse – which we are clearly not seeing at present – the optimism of consumer confidence surveys will fade and consumer spending will remain weak.

The long and short is that – come Summer – the inventory cycle’s thrust will have dissipated. And if companies are not hiring by this time and consumer spending is not increasing more robustly, then the state budgets, the strategic defaults and all of the rest of that becomes a serious obstacle. In my view, more likely than not, this will lead to another recession late in 2010 or in 2011. And nothing in the President’s budget changes this outlook.

  1. Vangel says

    I have a problem with your analysis. You seem to have fallen for the discredited Keynesian explanation of reality instead of looking at reality itself. Having governments tax individuals and spend to ‘stimulate’ the economy has never worked. Your assumption is that governments are better able to deploy the earnings they confiscate from the productive classes than the people who worked for those earnings. You could not possibly think that spending money that governments have is a good idea because that would mean placing a burden on future earnings. While it is possible to argue that there is nothing wrong in borrowing to build productive assets there is nothing that would suggest that government bureaucrats are better judges of what is productive than the private sector. From everything that I can see, most ‘stimulus’ funds are deployed to maximize political, not economic returns.

    As I have written before, we already have a model of how to handle a sever economic contraction effectively. Harding inherited a situation that was worse than the one that Obama got stuck with. Instead of raising taxes and spending as you suggest, Harding cut both taxes and federal spending. He stood aside and let the market liquidate lousy investments that could not satisfy consumer demand economically. As a result, the US went through a deep contraction that saw unemployment rise and GDP fall. But once the crisis was over the lower tax rates attracted new investors looking for an opportunity to become richer. Employment picked up and the economy grew rapidly.

    Instead of suggesting that Obama look to the Harding approach, you advocate the one taken by Hoover and FRD. They both advocated intervention that kept prices high and encouraged spending at all levels of government. They increased taxes and by doing so scared off potential investors who required some certainty in order to justify taking the risks. From what I see, Obama is also discouraging investment because he wants the productive class to pay its ‘fair share.’ This is in a country in which the total share of the income tax paid by the top 1% of income earners increased by around half, from 26% in 1886 to 37% in 2004. During the same period the bottom 50% of the population saw its burden fall from 6% to 3%.

    Frankly, I don’t see how rhetoric about how the rich have received ‘unfair’ tax breaks and how they have to be made to pay more will attract more capital to the US. Why would anyone build a factory if the government threatens to tax away most of the profits when it is far easier to take steps to protect one’s capital until the next regime shows more respect for productive risk takers. And how exactly does one get more jobs creation when productive investment is discouraged?

    The debate took place quite some time ago and the Keynesians lost their credibility because what they predicted was a miserable failure. I prefer to go with the approach that does make sense and clearly works. A review of the basics is probably in order.

    1. Edward Harrison says

      Look, Vangel, I don’t know what you’re talking about whatsoever. This post is purely about politics and has nothing to do with economic theory. I am presenting the political arguments now being made by the Obama Administration and how this is likely to box them in.

      As to the economics, the fact is if you reduce deficits, this reduces consumption by either increasing taxes or reducing spending. That makes a recession MORE likely. No one disputes this.

      The question is WHETHER to avoid the recession or not. Where I once said yes because of the threat of a deflationary spiral. That threat is still very real – but it is now clear that more government spending has only been used to continue misallocated resources and consumption which will not bring down excess private sector indebtedness. So I DO NOT advocate trying to avoid the recession through ‘stimulus’ what ever that might mean.

      But, let’s be clear, what the Obama Administration is doing has nothing to do with reducing deficits. It is political ploy that does nothing to address the real structural issues of military spending, healthcare and social security. If I were Obama, I would focus on those issues ONLY and forget about the others.

      1. Vangel says

        I responded to what you said in the interview.

        The BBC is using the typical pro-tax line and you seem to agree with it. You claim that having the tax cuts expire will help cut the deficit. I see it as a catalyst that destroys jobs and makes things worse as government becomes a bigger player and pushes out private deployment of funds.

        You are also questioning the need to cut the deficits because you fear the very contraction that is actually necessary before a true recovery can take hold. You claim that Obama should not care about the excessive spending because that creates a problem for the economy going forward. I claim that there is too much malinvestment that has to be liquidated so using more borrowed funds in order to keep malinvestments from being liquidated is a not a good idea.

        I see you trying to have it both ways. In some postings you make it clear that stimulus spending will lead to disaster because politicians will respond to political pressures and use the funds to prop up players that should be allowed to go under. But in other postings and interviews you claim that the Keynesians are right and that we need government spending to avoid a recession. You fail to point out what you seem to understand quite well in the other postings; that a recession is necessary to cleanse the system and allow a true recovery to take place.

    2. Marshall Auerback says

      “You seem to have fallen for the discredited Keynesian explanation of reality instead of looking at reality itself.”

      When I read this, Vangel, three words spring to mind: pot, kettle, black.

      1. Vangel says

        My claims are logical and defensible. The Keynesian approach has been discredited by real world observations. The planned economy approach that you advocate has always been a failure and you have yet to provide evidence or a logical argument that it is likely to be different this time. You even got the facts wrong when you claimed that Hoover was a free market advocate who did not intervene in the markets and failed to mention that FDR’s intervention did not cause the economy to recover but made a contraction into a Great Depression. Yet, you advocate doing the same thing as Hoover/FDR and rejecting the proven approach that caused a true recovery to take place.

  2. Nasser says

    Welcome to the 21st century

    Everything we learned in the 20th century is no longer valid in the 21st century.
    I think it back to school for all the so called experts including there [golden rules]
    The experts are dazed and no longer on the right path and or totally confused about what’s going on.
    I think its the [final count down] for Capitalism on global scale as we know it …
    God bless America [the last frontier]

    1. Vangel says

      There is nothing wrong with free market capitalism. What history has shown is that the crony capitalism cannot work because governments transfer wealth from savers and workers to their politically connected supporters.

Comments are closed.

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