While the patient remains on life support, some vital signs have returned. After a three-year bedside vigil, evidence of a pulse has garnered headlines, though the outcome is still in doubt. This is not a description of UT football or of some recent advanced cancer case, but rather the U.S. economy.
While languishing for 18 months after the supposed ending of the Great Recession, new federal fiscal income infusions are replacing last year’s support packages (the stimulus bill and TARP) that have run their course with little net positive GDP multiplier effects. But at least they put a bottom under the freefall. The new, less heralded government income support is in the form of a 2 percent reduction in the payroll tax that funds social security and an extension of unemployment benefits to the long-term unemployed, which is now pushed out to 99 weeks and will be extended as needed. This has turned a transitory job support program into a new welfare program. There is a sizable number of long-term unemployed Americans compared to past recessions, as shown in the accompanying graph.
Other entitlements are also being drawn against more heavily without the need for attention-grabbing Congressional votes such as food stamps; Fannie and Freddie subsidies, FDIC insurance losses and Medicare, and soon the start of the Baby Boomer’s Social Security will be upon us. Additional life support is provided in the form of accelerated depreciation of business capital expenditures, if they occur this year and the threat of tax increases has been pushed down the road for two years.
Setting aside the federal help given to the corporate sector, corporate balance sheets are in great shape (if the corporation can reach public capital markets). Corporate profitability growth is above the long-term trend given the slow growth of wages, increased productivity and foreign demand for U.S. exports that slightly reduces the trade deficit. The accelerated depreciation subsidy to corporate investment spending and increased profitability, in conjunction with the “don’t fight the Fed” mantra of stock market mavens due to the $600 billion QE2 program has lifted U.S. equity prices about 16 percent since the August lull in the economy. This in turn provides a “feel-good” wealth effect to consumer spending of perhaps a percentage point of additional GDP spending. All in all, most economists project a 3 to 3.5 percent growth of nominal spending, amounting to less than 2 percent in real terms given the acceleration in import prices, as well as food and energy prices. While this is good news, it is below a rate that represents a cyclical take off from recession that reduces the unemployment rolls.
Most of the perceived forward movement still derives from the federal dole, and lower interest rates have reduced the consumer debt service burden by 2 percent of after-tax income. These manifest infusions to current income flows have done little to revive the basic self-sustained momentum of the economy absent government and Fed help. Rather, this federal growth transfusion adds to the core debt satiation problem in which government debt grows at a rate faster than the income base to support the debt.
At some point the debt satiation will be addressed not because some brave politicians (as the Obama deficit commission has shown) will be willing to take the heat, but because the bond market will say no more. One only needs to observe the grip on reality that swiftly overwhelms the politician when the bond market cuts off a government from cheap financing. The contemporary anguish evident on the faces of European sovereign authorities or the U.S. state and municipality authorities when their debt is shunned by the market tells it all. This is the only discipline the politician seemingly understands.
To wit, in the year ahead it is estimated that state and local governments will face a combined $280 billion deficit with the municipal bond market not as likely to be as cooperative to allow them to buy time or excuse themselves from making the tough choices. If it results in state and local cutbacks of that magnitude, it offsets the marginal new federal fiscal aide in the pipeline, while the other Black Swan lurking in the background is the next episode of the European governments’ debt reality check.
It takes very little to get the stock market cheering section on its feet, but this is not an organic, post-WWII type of cyclical recovery as many claim. If it were, it would have multiplier effects—not just on spending and income: The federal government’s tax revenues would swell and entitlements would shrink so that the fiscal deficit shrinks as well.
As shown below, this is not the case today. This is growth bought and paid for with borrowed government dollars, adding to the fiscal deficit as a percentage of GDP. We are now above the 10 percent fiscal deficit line and growing. It’s not until the deficit/GDP curve heads downward will we know the patient is experiencing a self sustained recovery.
This is a vulnerable, mild income flow recovery that is overpriced in the equity markets. But it is not a recovery in the balance sheets of the consumer, small businesses, commercial banks, state and local governments, the central bank and most of all the U.S. government. That is the problem of the debt satiation economy. Until that occurs, we are living on borrowed time, which seems to fit nicely into the politician’s state of mind as they live from election to election. Because we are within two years of the next presidential go-round, this is the time frame to benefit from actions the government takes now so there could be yet more stimuli if the bond market allows.