If there is one explanation for why the equity market is rising despite the onset of what those on the left are calling a draconian cut in government spending, it is that the "sequester" that was triggered the other day doesn't cut spending at all. It merely slows the growth of government spending by a tiny amount. Dan Mitchell of the Cato Institute did a good job of illustrating this in a post a month ago, titled "Exposing the Absurdity of Washington's Anti-Sequester Hysteria."
He notes: "As you can see from this chart, the sequester will 'cut' spending so much that the budget will grow by 'only' $2.4 trillion over the next 10 years." Even with the sequester, federal government spending will rise this year, and it is scheduled to rise every year for as far as the eye can see. This is a "cut" only in the Alice in Wonderland world of budget-speak.
Investors are usually smart enough to see through the smoke and mirrors, and what they see is a slowing in the growth of government spending: something that is badly needed and long overdue, but nevertheless a step in the right direction.
As a reminder of where we stand when it comes to federal spending, I want to re-post the following two charts:
The battle that is being waged to slow the growth of government spending has actually been going on for the past four years, so this latest skirmish is nothing new. As the second of the above two charts shows, federal spending has already shrunk considerably relative to the economy, but it remains historically very high. If the very high levels of federal spending in the past four years failed to create a robust economy, then lower levels could arguably be a much-needed stimulus. Government spends money less efficiently than the private sector, so shrinking the size of government gives the private sector more breathing room and that in turn should create a stronger, healthier economy. It's a slow process, but we are making progress.