Friday, August 12, 2011

If A Recession Comes, Blame Washington

Earlier this year, NDD noted that Washington was a big negative wild card for the economy. Not being that politically astute I read over that statement, frankly not really knowing what to think. However, his statements to that effect now show a prescient reading of the landscape; Washington is indeed a huge problem and their current policy choices indicate they are as much the problem -- if not the primary problem -- in the current environment.

At the beginning of the year, the general economic consensus was for growth to start picking up. However, the EU crisis and the Japanese earthquake hammered growth in ways not anticipated. This was evidenced by the large downward revision to the first two quarters of 2011 growth, which printed two sub 2% quarters. This is a very discouraging sign.

Now, we have Washington focused on the need for "deficit reduction." Yet their solution -- which is disproportionately focused on cutting spending instead of a balanced approach between raising revenue and cutting spending -- is occurring at exactly the wrong time. This is born out by recent market events. Consider this chart:

The debt deal was signed on August 2. Since then, the stock market has tanked hard. Notice the massive volume on the sell-off and the incredibly strong downward sloping bars. Where is the euphoria? Where is the, "they got it right, the economy will now grow at strong rates so we should start buying shares" rally? Nowhere. In other words, the deal accomplished just the opposite of what the market wanted.

"But Bonddad! The economy is heading towards a double dip recession! We're doomed" As I've shown, there is little possibility of a double dip without recent events because there isn't much lower the economy can go. It's hard to see the economy dropping without a commensurate drop in housing. Yet housing is already bouncing along a bottom. And from an employment standpoint, it's hard to see how companies could cut any more employment fat from their budgets. The recent initial unemployment claims reading shows that companies are nowhere near the record lay-offs that occurred during the recession. Gas prices have dropped sharply, which is a boon to consumers. And consumer spending is moving sideways, not crashing. In short, the underlying data point to a 0%-2% GDP growth situation.

The problem with the debt deal is it took government action off the table at a time when governmental action is needed. Instead of borrowing at insanely low rates, investing massively in a degrading US physical and intellectual infrastructure, Congress is taking action off the table. Remember that governmental spending is a component in the GDP equation -- a fact lost in Washington policy debates, as is the different between consumption and investment. In short, Washington is focused on exactly the wrong thing at exactly the wrong time and as such should bear the brunt of any economic slowdown we face.