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.