The good news is the US budget deficit still looks to be plenty large to support modest top line growth and sustain and stabilise incomes, even if insufficient to generate any kinds of significant gains in employment.
As we’ve argued many times in the past, higher government deficits facilitate private sector deleveraging and continuously add to incomes and savings.
It is no coincidence that the financial burdens of households and corporations have continued to fall (and savings rates risen) as government deficits have increased.
Unfortunately, the new Congress appears serious about deficit reduction (See here). By next week, the House of Representatives will have a deficit terrorist majority, with many pledged to a balanced budget amendment. And the world seems to be leaning towards fiscal tightening pretty much everywhere.
If you want to get a good idea where the US could go, assuming our new GOP-led majority in the House are serious about budget cuts, take a look at the UK. The UK Office of National Statistics released the Labour force data for December 2010 a few weeks ago, which showed that:
The unemployment rate for the three months to October 2010 was 7.9 per cent, up 0.1 on the quarter. This is the first quarterly increase in the unemployment rate since the three months to April 2010. The total number of unemployed people increased by 35,000 over the quarter to reach 2.50 million … There were 839,000 people unemployed for over twelve months, the highest figure since the three months to February 1997 and up 41,000 on the quarter.
There were 158,000 redundancies in the three months to October 2010, up 15,000 on the quarter. This is the first quarterly increase in redundancies since the three months to April 2010.
The result was totally predictable in direction at least.
The ONS reported that “(t)he number of people in employment was 29.13 million in the three months to October 2010, down 33,000 from the three months to July 2010 … full-time employment … down 58,000 from the three months to July 2010 … The number of people in public sector employment was … down 33,000 from June 2010. The number of people in private sector employment was .. unchanged from June 2010″.
So instead of the public sector providing employment leadership at a time when the private sector is not yet ready to expand jobs growth, the British government (at all levels) has been cutting jobs and forcing unemployment up. As the austerity drive deepens the deflationary impact of these job cuts will undermine private sector employment growth. To top it all off, the British public received another New Year’s “gift” from the current Tory-Lib-Dem coalition via an increase in the value-added tax (VAT), going from 17.5% to 20%, effective immediately.
The austerity program is just beginning but has been signalled since the time of the coalition government’s budget statement last June. Public sector agencies are now contracting. Private business has had an opportunity to predict that demand conditions over the next 12 months are going to be tough and it is highly likely that they will deteriorate significantly. The neon sign that the British government has erected for private business is that spending is being cut and at least 330,000 thousand public sector workers will be without incomes (to spend) over the next few years.
One only has to recall the impact of a similarly misguided policy in Japan in the late 1990s, during which the Japanese government (expressing similar deficit phobias to that of the current Cameron Administration), raised the consumption tax from 3% to 5%, promptly plunging the country into renewed recession. The budget deficit itself (surprise, surprise), ROSE, as a result of the collapsing tax revenue.
Clearly, much of the emotion surrounding government deficit spending could be rectified if we simply viewed the deficits for what they really are: The budget balance is the difference between total revenue and total outlays. At the federal government level, if total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved. That’s it.
In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the budget balance moves towards deficit (or an increasing deficit). When the economy is stronger – tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilizers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom (see this for further explanation).
In the US, the attacks on public sector unions reflect another flank in this ruthless pincer movement on middle and working class Americans, as this NY Times article of January 1st illustrates. It is fascinating to see how the public narrative in the media has gradually shifted away; over the past year from Wall Street’s sociopathic practices (which were directly responsible for the creation of the crisis) to the alleged greed of public employee unions and their pension benefits, many of which were the product of agreed wage negotiation packages in which unions were receiving these pension benefits in lieu of increased wage benefits.
It’s not enough that the media regularly regales us with stories of “greedy” unions, whilst conveniently omitting that, in states such as New Jersey, the state has been raiding the pension kitty for over 15 years. Last year, for example, the fiscal austerians’ new poster boy, Governor Chris Christie, skipped the required $3.1 billion pension fund contribution last year. He claimed this move was to force reform, but what impact does another $3.1 billion failure to pay have on an unfunded liability that was already over $50 billion?
It’s interesting to observe the double standards at work here. During the period in 2008, in which the Federal Reserve authorised 100% payouts to the likes of Goldman Sachs on AIG’s credit default swaps (in effect allowing the Fed to act as an extra budgetary vehicle of the Treasury, which is a violation of the Constitution and shows how patently false the Fed’s claims of independence are), we were told that the government’s hands were tied and that sanctity of contracts had to be honored.
I don’t seem to recall many Wall Street types going on about sanctity of contracts when agreements with the UAW were reworked to save GM or during this period when public employee union pension benefits are under attack. The argument seems to be that the states are suffering from a genuinely solvency crisis in which everybody has to make sacrifices, including the “greedy” unions. So why should big financial firms, which would otherwise have been toast but for the munificence of the suffering American taxpayer, be any different? If the attacks outlined in the NY Times piece reflect a broader trend this year, then it has ominous implications for the country as a whole.
Another worry related to the potential diminution of spending power is the troublesome rise in crude prices. Net demand is not up appreciably, and Saudi production remains relatively low. Peak oil dynamics could well be at work here and in a broader sense, what Paul Krugman describes – “we’re living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices” – see here – could well prove accurate. Which, in the absence of countervailing support to incomes via fiscal policy or increased private sector activity which increases jobs, means cuts in other areas of discretionary spending, hardly a healthy trend in a world still constrained by inadequate demand.
Crude prices are already up enough to be a substantial tax on US consumers that has probably more than offset whatever aggregate demand might have been added by the latest tax package.
A federal pay freeze has been proposed. The Fed’s 0 rate policy and its continuation of “quantitative easing” both serve to reduce net interest income earned by the economy.
Bank regulators continue to impose policies that work against small bank lending, whose wholesale funding costs are substantially higher than their “too big to fail” counterparts. The Dodd-Frank “financial reform” entrenches the dominance of the systemically dangerous institutions at the expense of the 6000 or so other banks which engage in classic loan intermediation activity – the sort of thing we want our banks to be doing.
Overseas, the euro zone looks set to muddle through with very weak domestic demand. The periodic disruptions to the credit markets have hitherto been mitigating by repeated European Central Bank bond buying of the national debts in the secondary markets, but at the cost of further fiscal austerity being imposed on the periphery countries.
What about the emerging world, which has hitherto been held out as the major repository of global growth? Does China slow as a result of fighting inflation? Or Brazil? Maybe India as well?
Finally, there is the odious problem of political corruption which manifests itself in many forms, but most recently through the cynical revolving door policy between Wall Street and government. Peter Orszag’s move to Citi after spending months launching broadsides against Social Security from his perch at OMB and then the NY Times, goes beyond cynicism. Nobody expects a former government official to live like a monk after spending time in public service, but the idea that someone would help plan, advocate, and carry out an economic policy that played such a crucial role in the survival of a financial institution — and then, less than two years after his Administration took office, would take a job that (a) exemplifies the growing disparities the Administration says it’s trying to correct and (b) unavoidably will call on knowledge and contacts Orszag developed while serving at OMB – is sickening in the extreme. That his successor also comes from Citi simply perpetuates the incredulity. All this, under an ostensibly “progressive” Democrat Administration.
The revolving door between Wall Street and Washington calls attention to the fundamental core at the heart of the American polity today – what James Galbraith has felicitously termed “the predator state”. The state has become too weak and therefore remains another instrument of corporate predation. The revolving door policy (eagerly embraced by this President, much like his predecessors) perpetuates the problem because it enhances the dominance of the so-called “FIRE” (finance, insurance, real estate) sector of the economy. The FIRE sector simply acts as a parasite around the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs. Its revenue takes the form of what classical economists called “economic rent,” a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as “capital” gains. Its ethos consists largely of denuding the state of any provision of public goods, privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of convenient money (credit cards), or the credit needed to get by. It’s a zero-sum economic activity, meaning that one party’s gain (that of Wall Street usually) is another’s loss. It looks like we’ll have much more of the same as we enter into 2011. “Happy” New Year everybody.
Marshall Auerback has 28 years of experience in the investment management business, and he is a senior fellow at the Roosevelt Institute. He is also an economic consultant to PIMCO, the world’s largest bond fund management group. He writes a weekly column for Benzinga every Friday.
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