Smart Money with Keith Springer Saturdays at 1PM and Sundays at 6AM on NewsRadio KFBK 93.1 FM and 1530 AM

Critical Economic and Market Commentary 07/28/10

Fiscal Responsibility Will Bring America Back

The great recession was no freak accident or aberration. It was entirely predictable, just as I first wrote in my Economic Tsunami special report in December of 2007. An aging population entering its natural phase of reduced spending, plus a long period of national overindulgence that ballooned private and public debt, is producing a disastrous combination for which there
will be hell to pay. If we act wisely, America will be back stronger than ever. If we’re not careful however, we’ll be paying for a long, long while.

The public is doing its part, albeit involuntarily. In the last 12 months, private debt has declined by an astonishing $2.3 trillion, almost $800 billion more than the amount by which the federal government increased its debt in its attempt to fend off a deeper recession.

This has been led by adherents of Keynesian economics. They believed the government could stimulate demand with deficit spending. They boasted how increased spending and ballooning government debt would surely create a multiplier effect. “Don’t worry about the deficit” they would say, “for every dollar of deficit spending, there will be several dollars of new economic activity”.
Not to rain on our beloved government’s parade, my friends, but as Josh Billings liked to say, “It just ain’t so!”

Deficit spending does not energize an economy in any lasting way. It just creates another bubble of false demand—a bubble that will not only burst when the spending ends, but will leave you stuck with the bill long after you even remember what you bought. All this government debt has to be serviced by the private sector.

Sure, there’s some bang for the buck… or more like a whimper. For every dollar of debt, we actually get about 70 cents of economic activity. Then, when we have to raise taxes to pay for it, you get another whammy. That creates a negative multiplier. For every $1 in tax increases you actually put a drag on the economy of negative $1 to $3.

So that means we have a whole new set of worries—about $2 trillion in tax increases on the way. The $500 billion price tag of health care, plus the expiration of tax cuts (about $1.5 trillion over the next 10 years) will bleed $200 to $600 billion out of our economy PER YEAR, and just when the economy needs all the help it can get. This is pretty serious folks, especially when you consider that the growth in gross domestic product during the past four quarters was $400 billion.

This is going to be a very long process that will only get longer if we get deeper in debt. What this means is deflation. The good part of deflation is that interest rates stay incredibly low, lulling you into believing that increased debt can be easily serviced. The bad part is, well you guessed it: a very difficult investment environment. There are two examples in history. In our proud nation, from 1929 to 1941, interest rates declined, government debt soared, and stock prices got pummeled. Japan has experienced a similar crisis from 1989 to, well, now.

Don’t be fooled by the recent round of good corporate earnings. They have been mostly based on cost cutting and inventory restocking.

Take a look at Harley Davidson as a case in point. Their sales are plummeting (can anybody say demographics?) and they are laying off people but their profits are rising. That may be good for bonuses but not so good for the country.

Global economic growth will be appreciably weaker in the second half of 2010 and beyond. European austerity programs, a non-spending U.S. consumer (did I hear someone say demographics?) and attempts by China to rein in inflation will contribute to a general slowdown in economic activity throughout the world. All of this means, at best, subdued inflation, and at worst, deflation, as there is no aggregate demand.

Regardless of what I see, I remain open minded. I have been bullish for most of my 27+ years in the business and I would love to be again. However, I just call them like I see them and it’s our job to protect our clients the best that we can.

Don’t be lured into the rocks by the siren songs of recovery. Not when they’re being sung by politicians.

Regards – Keith Springer

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