Sunday, August 8, 2010

Two scoops of recession and a pinch of budget cuts!

The word on the streets is now there is a possible double dip recession in America. This is a considerable concern for not only large manufacturers in Asia and Europe, but also for smaller economies in the Western Hemisphere as we depend on American investment and tourism.

The American stimulus plans have run out of steam, with unemployment is still unacceptably high. President Obama, on the other hand, has said that there is no need for concern over a double dip recession in America- but, forewarned, is forearmed and the will of the possible, may not be the will of a natural course of events.

Simultaneously in and around Western European and American Consensus economic policy circles, is that budget cuts- and in some instances tax increases- is what should be done to stem the tide of fiscal deficits, even during this still yet sensitive time in the economy.

However, the ideas that: 1. Consideration’s over the option of more economic stimulus is out of the question and 2. Tax increases, in particular, is a desirable option, need more fleshing out in terms of their intended impact from a purely theoretical standpoint.

The first and obvious truth is that the American stimulus package did not go far enough. In fact, it has far less impacted America and the world, much more than it was billed to help.

For one reason, employment did not substantially grow over the course of the stimulus being rolled out. About 9.5 percent of Americans are unemployed, with business confidence still very low. In addition, the stimulus money way spent in areas that had little to do with the private sector, but rather with government sponsored programs that were and are short lived.

Service related jobs were not factored in to the American stimulus package, other than from “shovel ready” jobs- which were temporary- in addition to that creating more services related activity which didn't have a manufacturing base to support it.

For example, leading up to passages of both, The Economic Stimulus Act of 2008 and The American Recovery and Reinvestment Act of 2009, beginning from January 2007, business inventory rose by nearly 25% while service related work over manufacturing work increased considerably.

This displayed as well as created a major problem with the American stimulus plan; as the service related jobs were built around the government sponsored programs, they were not based on supply and demand for private investment along with an increase in manufacturing jobs outside of automobiles- which was also a government sponsored program for three of the top four automakers in the USA. And, as the money dried up, so too did the jobs and the economic multiplier effect that it temporarily displayed.

Even more so, a large amount of subsidies to private firms went towards technology, education and renewable energy. The first concern is that technology, need not be manufacturing based, especially with cheaper labor markets outside of the USA and global competition in the tech-sector being very stiff.

The second issue is that education does not stimulate the economy in the short term, especially when employment for trained professionals are even weaker than that of trained workers with years experience. And renewable energy is a new frontier and is a long way from being an economic staple for average consumers.

This added to the fundamental weakness in the structural economy of the USA- the main being that manufacturing has declined well below their peaks, even into the late 1980’s- , has led to current revenue shortfalls in addition to those forecasted.

The worst of it all is that countries in Western Europe, with Germany leading the way with respect to what they term “Ordnungspolitik”, are in the mood for not only budget cuts, but permanent budget cuts and tax increases as well as with Germany going through in the process of a wide sweeping deficit reduction program.

With the Euro-Zone and The USA representing over 40% of global GDP and, in turn, world production being affected by budget cuts and, in some instances, tax increases, the global economic outlook does not look so rosy, just yet.

Why are large European governments, with smaller countries following in lock step as much as they can, willing to sacrifice global economic recovery efforts rather than continuing to keep it afloat with additional credit?

The first issue is that it is seen that Keynesian spending, coupled with lower than normal interest rates, have not effectively dealt with the situation for the long term. In fact, I would be surprised if any economist, who is at the very least an observer of this crisis, would cant rip the public that government intervention is the measure that stops this recession.

With further respect to Keynesian spending, as a consequence, it, in effect, pulled private sector jobs into the government sector, with the government sector now being affected by budget cuts, which also signifies that if those government jobs were temporary- as in the case of the shovel ready projects- the private sector is back at square one and stuck with persons without the rigour of private sector competition, who would add dynamically less to the real economy.

A second issue is that sovereign bond yields affect public policy and economic policy making.

As government revenues decline, and if interest rates move lower, bond yields are adversely affected. For one, as the outlook for a country’s economic position worsens, governments find it harder to sell sovereign bonds at a higher rate. Secondly, as real “short term” interest rates move lower, in many instances, bond yields move higher as inflationary expectations are equated more so into financial risk matrices- which are also tied to the overall outlook of the economy.

Monetary policy is ever more important at times such as these. Interest rates have already been slashed, but this would be innefective if structural change and program design does not faccilitate the interest rate movements.

When the Central Bank is inactive with regard to market regulation, credit supervision and running the type of private sector related programs to assist banks with extending credit, while the economic landscape is still yet brown with deep-rooted buds are yet to take shape, using interest rates for private sector stimulation, is a zero option and an even more undesirable policy option to the extent it affects the bond market.

At the totally worse end, it is more damaging if monetary policy is not in sync with fiscal policy. It may lead to a loss to investors in the sovereign bond market as well as it may hurt Main Street in the short term if not negated by other economic policy measures.

From where I sit, it is a balancing act taking place in America and in Europe. They can afford to play the game with respect to large stimulus plans, budget cuts that affect economic recovery- while the smaller economies suffer as a result- and interest rate cuts- the latter probably causing what a liquidity trap.

Smaller countries are in a much different position and they need to monitor larger countries from a cautious perspective and continually seek to understand the causes of things.
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