Only Smart Spending Drives an Economy

Includes: DIA, QQQ, SPY
by: Vincent Fernando, CFA

Gary Burtless at the Brookings Institute makes a concise point that I feel is important to remember while being bombarded by the US government deficit debate. He inadvertently exposes some wrong-headed thinking at the same time.

The federal deficit represents a serious long-term problem. It is not, however, a threat to our economic recovery, nor will it be a threat anytime soon. Our near-term problem is weakness in private demand rather than excess government borrowing.

The most recent CBO forecast predicts a deficit next year of $1.43 trillion, or a bit less than 10% of expected GDP. While this is a shockingly big number, it is unlikely to pose an appreciable risk to the recovery. On the contrary, the tax and spending policies that cause the deficit are providing much of the stimulus that has reduced the severity of the recession and given us the prospect of an economic expansion this year and next.

It's true that the US still has a vast capacity to borrow, especially if Japan is any guide, and that US debt is unlikely to be a problem in the near-term.

Yet at the same time, we need to stop fearing lower near-term demand in the economy. Adding debt just to boost near-term demand data is from beneficial to the economy in the long term because not all spending is good.

This is because only smart spending decisions, whereby $1 spent ultimately results in more than $1 of value for the buyer, will grow an economy sustainably in the long-term. Less-than-smart spending, whereby $1 spent ultimately delivers less than $1 of value, may at first look like "growth" given that the spending numbers will show up in near-term data, but will in the end be value-destructive.

The problem, of course, is differentiating the two kinds of spending, which is almost impossible to do from 30,000 feet high at the government level.

Thus, weak demand may actually be a sign of smarter spending in the economy. While demand as a dollar value may appear lower, it is likely a higher quality sort of demand, whereby people and companies on balance are making smarter spending decisions.

As long as this is the case, whereby more smart demand is happening than less-than-smart demand, then net-net value is being created and we have nothing to fear.

What we should truly be scared of is the potential for well-intentioned yet naive policies pushing people into making more dumb spending decisions than smart, destroying value throughout the economy in the process.

To do such a thing, while adding mountains of government debt in the process, would be catastrophic.