Wednesday, October 27, 2010

The Dips In Congress Want To Legislate a Double Dip Recession

From Bloomberg:

U.S. House Republicans plan to try to slash $100 billion from the federal budget as early as January if they wrest power from Democrats in this year’s midterm elections, setting up possible early showdowns with President Barack Obama on taxes and spending.

Yesterday I described the US economy as a "second gear" economy. The economy is growing, but very slowly. However, there are several points that indicate a spark could lead to growth if given the right impetus. This also means the economy is far more susceptible to shocks such as a cut in government spending.

And no, this is not some theoretical model on which I'm basing this call. Austerity has been tried in the current environment several times and it has uniformly failed.

For example:

Neil Shearing, economist at Capital Economics in London, said the real lesson from the region was that, “aggressive fiscal consolidation at a time when the private sector is also retrenching is likely to lead to much weaker levels of activity and a surge in unemployment”.

Much like Spain, Ireland and the UK, the Baltic states were badly hit by the bursting of a credit bubble in 2008 that sent their economies into freefall and their budget deficits soaring.

While others cushioned the impact with stimulus spending, the Baltic trio plunged straight into austerity. As a result, they suffered the deepest recessions in the European Union last year, with Latvia’s economy shrinking by 18 per cent.

The region has since stabilised but, for many ordinary people it still feels like a depression. Wages have plummeted while unemployment has rocketed, with more than a fifth of the Latvian labour force out of work.

And then there is Ireland's High Cost of Austerity:

Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.

“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”

Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.

Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.

And countries that are proposing austerity measures uniformly agree it will lead to lower growth:

Britain will take an axe to its welfare state on Wednesday as part of an 80 billion-pound ($125 billion) cut in public spending that will dictate the future of both the economy and the coalition government.

After months of bitter negotiations, Conservative finance minister George Osborne will announce his spending review at 1130 GMT (7:30 a.m. EDT). Cuts of 25 percent on average are in store for most government departments outside priority areas.

Economists are split between those who say the drastic action is needed and those who argue it will tip Britain back into recession. Almost all agree, however, that growth will slow and the Bank of England (BoE) will have to keep monetary policy super-loose for the foreseeable future.

And here is another example:

Austerity measures aimed at bringing down Portugal's towering budget deficit are crucial to regain creditor confidence, Finance Minister Fernando Teixeira dos Santos said Saturday, while also acknowledging that they will slow down economic growth next year.

Measures contained in the government's 2011 budget proposal are intended to "not only reduce the deficit, but will also regain the confidence of those who lend to Portugal," Mr. Teixeira dos Santos said at a news conference explaining the proposal, which the minority government late Friday had presented to parliament amid continued uncertainty on its approval.

The government expects gross domestic product in Portugal to recover by 1.3% this year, but the harsh austerity measures included in the proposal will contribute to a slowdown in GDP growth to 0.2% in 2011, Mr. Teixeira dos Santos said, because the measures will have an effect on domestic demand.

Folks, this is not difficult. First we have data -- as in facts and figures -- that can tell us is this is a good idea right now. The facts indicate it is not a good idea. And no, this is not some complicated mathematical formula. In fact, it's simple math -- hell, it's even addition which you can do on your fingers for God's sake.

Here is the GDP equation:

consumer spending + investment + exports net of imports + government spending =GDP

So, if we lower government spending (which BTW has historically accounted for about 20% GDP for the last 30 years) we are lowering GDP by definition.

There is a time to put the fiscal house back in order. When GDP growth is slow, unemployment is high, consumer spending is slow, the housing market is trying to recover and demand is soft, cutting spending is a really bad idea -- as in probably the worst idea you can imagine.