With the debt ceiling agreement almost a certainty this past Sunday evening, the expectation was the markets and the economy would rebound briskly the following day. After all, weren't we all bombarded for weeks with the message that if the debt ceiling were not raised, the economic sky would fall in? The economy would tank? Economic Armageddon was coming? So, if we raised the debt ceiling, the markets would rebound, right?
On Monday the stock market at first did rebound on the news of the imminent debt deal, but only briefly and modestly. It quickly turned around within hours on Monday, declining sharply by the end of the day. Why? The debt deal was in the bag by Monday. The recalcitrant House and Teapublicans voted for it. Only the formality of the Senate voting on Tuesday remained. Why wouldn't the markets, falling most of the previous week, snap back with the conclusion of the debt deal?
Instead, the markets slumped badly by the close of business on Monday, not because of the debt deal, but in response to a report late that morning showing the July US manufacturing activity index had fallen to 50.9 percent in July from 55.3 percent in June - the largest collapse in years and to the lowest level since June 2009, which was the trough of the recent recession. Fifty percent for the manufacturing index represents no growth. That's stagnation. Even more serious in the report, future orders for manufactured goods fell to 49.2 percent - a clear contraction - the first such since June 2009, as well. In other words, in terms of manufacturing at least, the economy now was right back where it was two years ago.
No wonder the stock market shuddered on Monday, notwithstanding all the "good news" about the debt deal. The performance of the real economy was far more important and "real" than all the huff and puff about debt ceilings and defaults by the US government. The alleged "good news" of the debt agreement was overwhelmed by the undisputable "real news" that the real economy was heading for a relapse.
And it was not just the US economy. Not reported by the US press on Monday was that the US manufacturing index's nearly 5 percentage points drop was being echoed at the same time by a decline in global manufacturing - in Europe, UK, Asia, even China. All reportedly had begun to slip.
On Tuesday, the debt ceiling deal was voted up by the Senate and signed by Obama into law. But the New York Stock Exchange fell by another 265 points and the NASDAQ by a whopping 75. Wait a minute! The debt deal was officially done, wasn't it? No chance of a reversal. So, why did the markets finally respond so negatively? The "real" reason was a further report on Tuesday. Consumer spending - representing 70 percent of the economy - fell by 0.2 percent, the first drop since September 2009.
In the face of this evidence of imminent contraction of the US economy, Congress voted to cut deficits in the amount of $1 trillion for certain, with another minimum $1.2 trillion in spending reductions due before the year end. Granted, much of that $2.2 trillion will be spread over ten years. But there will be about $30 billion in immediate cuts this year from the initial $1 trillion deficit reduction. Most of that will come from education, and still more, and bigger, first year spending cuts before year end.
The second round of $1.2 trillion in cuts will likely equal at least another $50 billion to $100 billion in the short term, most of that from Medicare-Medicaid and a lesser, token amount from defense, this writer predicts. That's about $100 billion in total federal government spending cuts impacting the economy this coming year. Add to that the $38 billion in cuts in spending enacted last spring in revisions to the 2011 budget, plus another $100 billion spending cuts forecasted by state and local governments the coming first year, and what you get is around $250 billion in spending reductions for the coming year.
But this $250 billion's impact must be "multiplied" to get its true, final economic effect. Economists estimate the "multiplier" from government spending at about 1.5. That means for every $1 cut in government spending, about $1.5 dollars are taken out of the economy. The first year of cuts are therefore $375 billion to $400 billion in terms of their economic effect. Ironically, that's about equal to the spending increase from Obama's 2009 initial stimulus package. In other words, we are about to extract from the economy - now showing multiple signs of weakening badly - the original spending stimulus of 2009!
As others have pointed out, that magnitude of spending contraction will result in 1.5 million to 2 million more jobs lost. That's also about all the jobs created since the trough of the recession in June 2009. In other words, the job market will be thrown back two years as well.
With the debt ceiling deal, the US Congress and the president have crossed the bridge into the parched desert of "austerity." This is an historic juncture, shifting from stimulus to grow the economy out of recession, to austerity to thrust it back into recession! But the politicians of both parties are due for a rude surprise. Deficit cutting and austerity will result in worsening deficits and more debt - not reductions in deficits. An economy cannot cut its way out of a deficit and recession any more than a company can cut its way back to long-run profitability. It can only grow its way out by generating more revenue. For a company, that means selling more products and sales revenue; for the economy, that means creating more jobs and raising tax revenue.
Austerity solutions are a dead end. If anyone believes austerity solutions are the answer to recovery, they should simply look at Greece, Ireland, and the rest of the periphery of the eurozone. Imposing austerity there has resulted in a further deepening recession, falling tax revenues and still worsening deficits and debt. Ditto for the conservatives in the United Kingdom, whose recent deficit cutting is now thrusting that economy back into recession. The same is inevitable for the US if it continues toward austerity, deficit and spending reductions as a way to recovery. To employ a metaphor, austerity is like trying to win a race by shooting yourself in the foot at the starting block.
Nevertheless, it appears more austerity is on the agenda in the US - the next round in the 2012 budget negotiations due by October 1 and further in the December cuts that will be mandated by the so-called Bipartisan Committee; and following that, still more cuts, this writer predicts, in 2012, as the recession wipes out a good part of the prior spending cuts.
More cuts will follow because, despite the deficit cutting, the US budget deficit will now actually worsen and not improve. As the economy slides, tax revenues will fall below those officially projected, generating a call for even more cuts from those who believe deficit and debt reduction will restore business confidence and, therefore, investment and recovery.
All the talk about restoring business confidence is, in other words, simply a "confidence game." Collapsing business confidence is a consequence not of deficit cutting, but of consumers being unable to afford to buy their products. Want to change business confidence? Help consumers buy their products and see how fast that confidence returns. Adding two million more to the total jobless will only reduce consumers' income further, exacerbate the decline in consumption already underway and result, in turn, in a further deterioration of business confidence.
The past few days, the US economy has been dealt several severe blows in the reports on manufacturing decline and consumers retreat - a "one-two punch." Over time, the realization will grow that the deficit cuts - $1 trillion now and another $1.2 trillion in a couple months - will do great harm to the economy. The cuts represent another major "body blow" to the economy that is already rapidly weakening. The markets know this. "Business confidence" knows this. Apparently, only the politicians don't.
And more is yet to come. On Friday, the jobs report for July is due for release. July and August employment reports will show even more clearly the serious extent of the economic slide now underway. The coming jobs reports could prove a "knock-out" blow to the economy. The "big money" investors are already betting on that outcome. Dump your stocks and stuff your closet with bonds! The recent debt ceiling debate, in retrospect, appears as just the opening act, with the amateurs (Congress and Obama) flailing at each other, until finally exhausted and calling it a draw, returning to their respective corners to catch their breath. The "main event" is yet to come.
In early 2009, Obama implemented his economic stimulus and recovery plan. The Congress and US Treasury spent $2 trillion and the Federal Reserve more than $9 trillion to bail out the banks. What we got was the weakest and most lopsided recovery since 1940. After a brief twelve months, the economy sagged again in last summer 2010, followed by $600 billion more Fed stimulus, and $350 billion more tax stimulus at year end 2010, which included $250 billion in Bush tax cut extensions. The result? The economy slowed again, even more quickly, to less than 1.0 percent growth in GDP the first six months of 2011. The current third quarter, July-September 2011, will likely prove worse. Stepping into that ring are Congress and Obama. Double-dip recession will be their joint legacy. And if the banking system implodes in Europe, the outcomes will be even worse ... much worse.