Assuming that government revenue does not collapse, it is not a stretch to say that there is no political appetite for either maintaining or growing the Federal deficit. The assumption is that change in Net Government Spending will be no less than the $838B reduction (per year) by 2014 put forth by the Obama administration.
This amounts to more than 5% of present GDP. With the output gap already just under $800B (or 5% of GDP), that makes the hole 10% — with 16% under-utilisation of employment at present with just a 5% output gap.
It is difficult to see this gap being filled by private spending, given that even with the present fiscal support, it is presently being filled at an annualised rate of just $5B per year.
This, of course, is likely good for the US dollar.
While this is ultimately may be a deflationary force which will reduce income both domestically and globally, perhaps the first quarter GDP numbers actually provide an optimistic scenario for a successful hand-off from the public to private sectors.
Despite the softness in GDP as a whole, Gross Private Domestic Product (pictured above) increased at a 5% annualised rate in 1Q — the fastest pace in the recovery to date, and indeed since early 2007. Federal expenditures declined 7.9% in the first quarter. Despite this, nominal GDP increased by 3.1% (1.8% in real terms).
So, what can cushion national income from the further evaporation in government spending? You could make the argument that it will positively impact the trade balance. Government spending which leaves the economy to purchase oil may result in some shift in output to actually export as we move closer to economic equilibrium.
A freshly weak dollar is promoting cheaper American exports, so perhaps some of this will be absorbed, but it is doubtful that the newly excess capacity will be well configured for the output of manufacturing, whether for increased domestic consumption or exports. Assuming an extremely optimstic (doubtful given the demand slack domestically & in developed nations) historical covariance continues, that may recover some $250B of $800B.
The parachute very well may be private credit. It is probably safe to assume that housing equity will at least be flat (if not continue downward), but there is some life in Business & Industrial Loans, as well as Consumer Credit. Assuming this returns to a more historical growth rate of 7% (presently at 5.9% annualised, up from 3.3% the previous month), this represents a bridge of an additional $256B.
The present reduction in Personal Savings & rebound in credit has certainly been what has allowed Gross Private Domestic Product to outpace the contraction in government spending in Q1.
It certainly is an interesting scenario: the government is stepping back, pushing the economy off the ledge, and hoping the banking sector will catch it. The Senior Loan Officer Survey suggests that both the willingness to lend & demand for loans may be partially supportive of this.
At present, gross private domestic product growth of about 5.5% presents a ceiling to our growth. What coefficient would you calculate on recovering the lost government spending as private sector income?
That’s another article for me. In the mean-time, I’d like your comments on it.