How To Redefine The Terms Of A 'Grand Bargain' To Avoid The Fiscal Cliff And Provide Growth

Includes: DIA, QQQ, SPY, XLF
by: HiddenValueInvestor

The "Grand Bargain" has been coined to be an agreement between Republicans and Democrats to raise tax revenues and cut federal spending in order to lower the federal budget deficit. But with 7.9% unemployment and GDP growth of just 2% for the third quarter, the economy remains too weak to create good jobs for the millions of people in the U.S. who need to find work.

The currently sought after "Grand Bargain" is based on an Austrian Economic viewpoint that the federal government should step out of the way of stimulating the economy with deficit spending because it will only make the misallocations and malinvestments worse. Austrians believe the solutions to economic downturns is to let the free markets work to clear the market by letting prices and production bottom out until demand returns.

Instead, it is time to use the pending fiscal cliff to offer a newly defined Keynesian Economic viewpoint driven "Grand Bargain." Keynesian Economic Theory suggests that downturns in the economy are based on a lack of demand and when the private sector is unable to create enough demand to create jobs the federal government should step in to stimulate demand with increased deficit spending and tax cuts.

A new Keynesian based "Grand Bargain" would require each side to actually ask the opposite from the other side of the aisle. Rather than asking for an agreement to raise tax revenues by either raising tax rates or eliminating deductions in exchange for spending reductions, the new "Grand Bargain" would ask for additional tax cuts in exchange for an increase in additional stimulative spending. The Keynesian viewpoint is that both tax cuts and additional spending stimulate demand thereby creating jobs.

For those worried about the debt interest rates for 10 year Treasury Bonds are currently 1.6%. More importantly, according to Modern Monetary Theory, the U.S. owes everyone dollars and it can create more dollars whenever it is necessary. According to Modern Monetary Theory the U.S. can never go bankrupt as long as it has sovereignty over its money supply and it owes everyone that money only. Modern Monetary Theory, an offshoot of Keynesian Economics, would call for massive tax cuts and very significant increases in federal government spending until the economy rebalances the job market.

It has been widely accepted that World War II spending ended the Great Depression because it was on a massive scale relative to the size of the economy. In the post World War II era, both Republicans and Democrats have been adherents of Keynesian Economics. The current "Grand Bargain" is based on an Austrian economic model that is being forced on countries like Ireland, Portugal, Spain, Italy, and Greece and it is killing economic growth in those countries.

Unemployment in Spain is now over 25%. Because the U.S. has sovereignty over its money supply, unlike those other countries that have adopted the euro, the federal government is not constrained by markets or rating agencies in how much money it chooses to spend. A new "Grand Bargain" would be win, win, win. Democrats could keep the social safety net, Republicans could keep Defense spending and push through additional tax cuts, and millions of additional Americans could find meaningful employment. Once jobs are created federal social safety net spending will actually decrease and federal tax revenues will rise from both new workers paying taxes and from the increased profits in the private sector of the economy.

The currently proposed "Grand Bargain" will represent a drag on economic growth, whereas a new "Grand Bargain" would stimulate growth. Investors in stocks should closely watch the outcome of the fiscal cliff negotiations for clues as to whether or not the coming agreement would represent a fiscal drag or a fiscal boost on the economy. The major banks such as Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), Bank of America (NYSE:BAC), Citicorp (NYSE:C), and Wells Fargo (NYSE:WFC) will raise or lower their 2013 economic forecast models and correspondingly their 2013 outlook for the S&P 500 Index (NYSEARCA:SPY) and the NASDAQ 100 Index (NASDAQ:QQQ) based on the agreement.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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