To spend or not to spend is the biggest dilemma for policymakers in the United States at this juncture. This article looks into the forecast made by the CBO if fiscal restraint were to be exercised in 2012 and 2013 and its implications.
The CBO Projections
According to the CBO, the "fiscal cliff" will result in a reduction in the federal budget deficit by $607 billion (4% of GDP) between fiscal years 2012 and 2013. This might seem desirable for a government that is already burdened by significant leverage.
However, the CBO also projects the following:
Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5%, CBO expects -- with the economy projected to contract at an annual rate of 1.3% in the first half of the year and expand at an annual rate of 2.3% in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.
At the same time, the CBO release also projects the GDP growth if the fiscal restraint were not exercised. According to the release:
CBO analyzed what would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1% of GDP between calendar years 2012 and 2013. In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4%, well above the 0.5% projected for 2013 under current law.
My Opinion on These Forecasts
I personally don't believe that the U.S. economy will grow at 4.4% if the fiscal restraint were not exercised. Projecting a growth of 4.4% is way too optimistic under the current global economic scenario. At the same time, I agree that a recession could be avoided if the fiscal restraint were not exercised.
I discussed in one of my earlier articles the prospects of a global recession. I reiterate my view on that and I do believe that spending cuts on the part of the government at this point would accelerate the progress toward economic contraction.
Having said that, the key point to consider here is: Will the economy keep needing government support over a prolonged period to avoid slowdown or recession? In my opinion, U.S. economic growth and economic growth in Europe will remain sluggish for a prolonged period. What follows is that the government will have to keep spending in order to support the economy. Therefore, the fiscal restraint program might get deferred to eternity.
This is where some political will on decision making will be needed. The growing debt path is most likely to be unsustainable in the long term and will lead to multiple problems for the U.S. and the rest of the world. In my opinion, a better solution would be to tread the balanced part and cut government spending gradually at the expense of allowing weak economic growth for the medium term.
Instead of excessive government spending, favorable policies for corporate should be in place, defense spending needs to be cut, and public/private partnership would be needed in infrastructure and manufacturing. These measures would be more favorable for the economy in the long term. It has already been seen that government spending since 2008 has done nothing extraordinary in terms of creating jobs or helping the middle class to maintain its standard of living. I discussed this in one of my earlier articles on the real unemployment rate in the U.S.
Therefore, the government sector needs to shrink and the private sector needs more favorable space to expand and grow. It is known that the Obama administration has kept the private sector guessing and on hold for a number of policy changes. This does not help the economy even an iota.
What Will Happen?
What I discussed above was largely my opinion. Going by the statement and history of policymakers, I am sure that there will be no cut in government spending in 2013. In my opinion, the budget deficits are likely to cross over a trillion again.
A weakening global economic scenario will give enough reasons for the policymakers to convince the market that more quantitative easing is needed. I will also not be surprised if the government has deficits of over a trillion dollars over the next few years as well. Therefore, the concern related to government spending cuts is not warranted, and policymakers will not disappoint the markets at any cost. However, economic contraction for a quarter or two can still be likely if the economic scenario in Europe and China worsens.
What Do Investors Need to Do?
Investors should stay long and buy on corrections:
- SPDR Gold Trust ETF (NYSEARCA:GLD)
- iShares Silver Trust ETF (NYSEARCA:SLV)
- iShares S&P 500 Index ETF (NYSEARCA:IVV) or SPDR S&P 500 Index (NYSEARCA:SPY)
I would like to remain long on equities because I believe that they would provide better returns than long-term government bonds. Furthermore, the corporate sector in the U.S. is competitive, innovative, and dynamic. Therefore, in the long run stocks should do well in an environment of excessive money printing.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.