U.S. Economic Woes Are Home Grown: Just Ask Arnold

While much attention has been focused on increased spending at the federal level in the United States, whether bank bailouts or stimulus packages, the spending cuts by local governments and individuals have acted in the reverse direction. This is going to make the recession longer and deeper than optimists believe.

Just look at the fiscal nightmare now confronting Californian Governor Arnold Schwarzenegger, with a pay cut so far of 14 per cent for 235,000 state employees. Arizona, Indiana, Ohio, Connecticut and Missisippi are among other states facing major budget deficits and spending cuts because the recession is slashing tax receipts.

Consumer cutbacks

At the same time US consumers are saving and not spending, with the annual savings rate now at a 60-year high of $769 billion. That is money coming out of the US economy, and if the figure looks familiar that is because it is almost the same size as President Obama’s stimulus package.

The federal government has been attempting to save the US economy from an even deeper slump by its interest rate cuts, bank bailouts and stimulus measures. But this is being at least partially undone by private savings and spending cuts at the state level.

However, there has always been considerable doubt among economists about a country’s ability to spend its way back to prosperity, especially in a nation whose economic problems arise largely from overspending and debt, particularly housing mortgages.

When households have overspent they have two solutions: sell the house or cut spending to service and repay loans. Remortgaging and indulging in another round of spending would not make this situation better. It would create a worse position with bigger debts and a longer time horizon for repayment.

The equivalent for a nation is a long recession, a period of below average consumption to make good some of the acummilated deficit. But the danger then is that this downturn in consumption can compound into a deflationary spiral and depression.

Pain to come

Economists are only too aware of this problem, and that appears to have made some investors overconfident about a quick solution. The reality is more subtle, and while some of the very worst of the downturn can be avoided that is a considerable difference to avoiding it all.

It is this unwinding of negative personal and state balance sheets that is going to prolong this recession, which may be less than half-way done. And while that is happening there is the threat of a further banking crisis as bad loans continue to be unwound both for personal and corporate credits.

And a final sting-in-the-tail is likely to be a bond market crash as the public sector will eventually only be able to borrow to meet its commitments by paying very much higher interest rates. The recession is therefore far from over.

Comments

[Larry House:]

The unwinding is certainly less than half accomplished, and don't leave out Illinois from the list of shame. This unwinding on a personal and state level will take years, not months.

Jul 06 10:51 AM

[aldol:]

stimulus packages simply shifts money from private industry to public finances.
hitherto results in chocking the economy and delaying the recovery

Jul 06 10:57 AM

[Mad Hedge F...:]

Arnold is in a tight spot. ) Perhaps it was deliberate that AMC Channel featured an Arnold Schwarzenegger film festival this weekend. Was the gratuitous violence of Terminators, Judgment Day, and the End of the World intended to drive us all to the negotiating table (“speak to the hand”)? We now have a new currency in circulation, Golden State script, which is thoughtfully being printed in green as I write this. Of course the banks haven’t said they will accept this past July 10, so many spent the July 4th weekend at Big Five Sporting Goods stockpiling ammo and drinking water (everyone here already owns guns), possibly inspired by the Arnold movies. Many schools have already cancelled summer school, so of course, the malls are full of jobless kids lounging around and smoking cigarettes, with nothing to do. Towns are going without fireworks celebrations, and worried citizens are bracing themselves for a complete cessation of state services by the fall. Obama has wisely turned a blind eye to all of this, leaving we non taxing big spenders to stew in our own manure. For more on this see my earlier piece at madhedgefundtrader.com.... With everyone of all parties thoroughly disgusted with our leaders, I’m surprised that the grass roots campaign for a state initiative to dump the two thirds majority required to pass a budget, hasn’t welled up yet. Does France still have that guillotine thing? Is it available for rent?

Jul 06 11:28 AM

[jambo:]

"With everyone of all parties thoroughly disgusted with our leaders, I’m surprised that the grass roots campaign for a state initiative to dump the two thirds majority required to pass a budget, hasn’t welled up yet."

Right-on, let's make it so that endless throngs of homeless who have moved here for the beloved weather/handout ratio, can more easily vote to tax anyone with any money left so they arent troubled to actually achieve anything in their own lives. Damn, sign me up!!!

Jul 06 12:20 PM

[conceptwizard:]

The trillions of dollars that the Bush and Obama administration have given away to Wall Street would have been enough to buy a great bulk of the mortgages now in default – mortgages beyond the ability of many debtors to pay in the first place. The government could have enacted a Clean Slate for these debtors – financed by re-introducing progressive taxation, restoring the full capital gains tax to the same rate as that levied on earned income (wages and profits), and closing the tax loopholes that effectively free finance, insurance and real estate (FIRE) sector from income taxation. Instead, the government has made Wall Street virtually tax exempt, and swapped Treasury bonds for trillions of dollars of junk mortgages and bad debts. The “real” economy’s growth prospects are being sacrificed in an attempt to carry its financial overhead.

Jul 06 02:10 PM

[User 353732:]

The truly great threat to the economy and later national security and global stature of America is not the private unwinding but the parallel public winding.
America has the strategic depth to endure and quite quickly manage an orderly private unwinding which, unimpeded, would now be mostly over with the end in sight.
America, however, does not have the strategic depth to afford the great public winding that is now underway. This great winding, perhaps the greatest exercise in fiat money, fantasy debt and unreedamable financial obligations in recorded economic history will, inevitably, be followed( who can predict when ?) by the most destructive debt unwinding and strategic erosion any major economy and dominant geo-strategic power has known.
The price of the public unwinding could be a deeply demoralized and much diminished middle class, the decisive loss of America's stature as the first and only global hyperpower, the humiliating demotion of the dollar as the only reserve currency( to one of 3 or 4 reserve currencies/transactional media, maybe) and the end of American exceptionalism.
Too late, scores of millions of Americans will realize that, eventually, all debts must be repaid and if the debt is enormous enough , not with money but with things even more precious. This time the precious thing many Americans will be forced to give up will be the American Dream for themselves, their children and grand children.

Jul 06 04:04 PM