Whatever else they say – they all know that public spending cuts are bad

As an outsider, US Presidential campaigns are very curious events. But that is not my topic today. Well it sort of is my topic. The US President has recently visited Virginia – a place where defense spending appears to be highly concentrated. Various senior Republicans decided to give the President a lesson in economics. The only problem is that the lesson seems to run counter to what their main hope – Mitt Romney – is trying to say. In fact, they all got themselves tangled up in a logical mess. But the truth that emerges is that – whatever else they say – everyone of them knows that public spending cuts will damage the economy. They also all know – whatever else they say – that at this present time – with private spending so weak – that such a slowdown will be disastrous. They also know that the American people are pretty easily duped by conservative talk and religious invocation. And that is the way they plan to get power. What happens to the unemployed is just a side-issue it seems. Makes you wonder what went wrong with public education in America (that these characters can be taken seriously)!

If we were to summarise the main message of the US Republicans at present it is that we all need to be fiscal conservatives and cut net government spending to give the private sector space to grow. There can be no other interpretation .

President Obama visited the US state of Virginia recently. To demonstrate how on top of their message they are – the Republican heavy-weights lined up to greet the President with an exercise in economics.

First, the Governor of Virginia released a press statement (through Mitt Romney’s Press machine) on July 12, 2012 – President Obama’s Lack of Leadership Puts Our National Security At Risk – which said:

“Virginia is the home of America’s military. We are home to the Pentagon, to Quantico, to Norfolk, to Langley AFB, and so many other critical components of our nation’s armed forces. The President has put our defense budget on course for radical cuts that even his own Secretary of Defense says will be “devastating” to U.S. national security. An American president’s most fundamental duty is to protect our country. As the Governor of Virginia, but also as a veteran, the son of a veteran and the father of a veteran, I fully understand that what is at stake is not only a potentially major economic blow to the Commonwealth but a great deal more: namely, our national security in a dangerous world.”

Did I read “a major economic blow” would accompany the spending cuts?

Did I infer from that – that without the public spending in the state, employment will fall and the lack of soldiers would be risky (that is, output falls as well)?

Then the Governor-in-Waiting, one Bill Bolling released a press statement on the same day – President Obama’s Cuts Will Hurt Virginia’s Economy – which expanded on the theme. He said:

We are very concerned about the impact that sequestration could have on Virginia’s economy. We all understand that budget reductions have to be made, but we need to make targeted reductions, and we should not expect the defense budget to carry a disproportionate share of the cuts.

If sequestration proceeds as the President wants, it could have a devastating effect on the military which would adversely impact Virginia’s economy and leave the nation less capable of defending our interests. It could also deliver a devastating blow to the private sector defense contractors who make up a big part of Virginia’s economy, especially in Northern Virginia and Hampton Roads. This is just another example of how the President’s approach to running the country is jeopardizing our economic viability.

Reads like a Keynesian.

Then Virginia’s Attorney General, one Ken Cuccinelli came out blabbering – that the “damage to our local economy here in Virginia will be enormous”.

Did I read that the public spending cuts will create enormous damage to the economy? I thought I did?

And we better not forget the so-called – Welcome To Virginia President Obama” Press Conference Call – hosted by Mitt Romney on July 12, 2012. The Republican representative, one Randy Forbes was ebullient in saying:

So if you look at it from an economic point of view, this is something that is going to have an enormous, devastating blow on Virginia, especially in northern Virginia and in the Hampton Roads area. Final thing, Senator, as you know, this not just about individuals in the military, although 200,000 or so of them are going to get these pink slips. It’s not just about defense contractors, which is going to be huge for them because these pink slips are going to start going out in October from a lot of these defense contractors. But it also is going to have a huge impact on beauty salons, restaurants, car dealers, the entire economy as you have this unstable situation that’s there. That’s why we’re hoping in November we’re going to get a Commander-in-Chief that’s going to say ‘we’re going to stop this from taking place.’

Reads like he considers there are enormous positive spending multipliers associated with public spending. Induced spending spill-overs – spreading throughout the economy.

The sequestration they are referring to is of-course the spending cuts that were agreed when the Republicans held President Obama to ranson last year over the public debt-ceiling. From January 2013, the US government is due to make significant public spending cuts some of which are targetted on defense.

So why is Mitt Romney calling for a Smaller, Smarter, Simpler Government – claiming that:

The mission to restore America to health begins with reducing the size of the federal government and getting our fiscal house in order. President Obama has put our nation on an unsustainable course. Spending is out of control. Yearly deficits are massive. And unless we curb Washington’s appetite for spending, the national debt will only continue to grow.

As president, Mitt Romney will cut federal spending and regulation, and bring much-needed reforms to Medicare and Social Security. Mitt will work toward balancing the budget, reducing the size and reach of the federal government, and returning power to the states and the people.

Which according to Mitt Romney is essential to his “plan to get America back to work”.

The indelible illogicality of all this is one of the reasons that these US Presidential campaigns are curious events to an outsider.

An outsider has to ask – is the US education system so bad that the American people cannot see how stupid the main contenders for public office are taking them to be? That is, are the American people as stupid as the politicians consider them to be!

With my fire suit neatly on, we can proceed.

Yesterday (July 17, 2012), the US Federal Reserve Governor appeared before the US Senate Committee on Banking, Housing, and Urban Affair to present his – Semiannual Monetary Policy Report to the Congress.

The Governor’s contribution can be quickly summarised – no more quantitative easing (presumably because they have finally worked out it does not provide much or any stimulus) and no other sort of Federal Reserve intervention (presumably because they have finally worked out that the problem is fiscal and monetary policy is a vastly unsuitable tool to be used if the aim is to stimulate aggregate demand).

Governor Bernanke said that “economic activity appears to have decelerated somewhat during the first half of this year” and that slowdown will continue.

He said that household spending growth will slow down. Manufacturing output has slowed. And the “rise in real business spending on equipment and software appears to have decelerated” and that “(f)orward-looking indicators of investment demand–such as surveys of business conditions and capital spending plans–suggest further weakness ahead.”

The slowdown in Europe is also “restraining the demand for U.S. exports”.

So pretty much all the non-government components of aggregate spending are in decline and this has led the US Federal Reserve to reduce its growth forecasts – “reflecting the generally disappointing tone of the recent incoming data”.

He noted a number of “headwinds” that are holding back economic growth in the US and overall:

… given that growth is projected to be not much above the rate needed to absorb new entrants to the labor force, the reduction in the unemployment rate seems likely to be frustratingly slow. Indeed, the central tendency of participants’ forecasts now has the unemployment rate at 7 percent or higher at the end of 2014.

In other words, a very gloomy outlook for Americans.

So what is holding America back? As far as Ben Bernanke can see it is two things:

The first is the euro-area fiscal and banking crisis; the second is the U.S. fiscal situation.

He claims that “the European authorities have both strong incentives and sufficient resources to resolve the crisis”. Which means he thinks fiscal austerity is the way to resolve an aggregate demand failure.

Come in Mitt Romney – except if it concerns defense spending, which then elicits more widespread cuts in consumption spending that impacts negatively on the beauty salons, restaurants, car dealers – in fact – the entire economy.

Curious.

In relation to the US fiscal situation, the US Federal Reserve Governor said:

As is well known, U.S. fiscal policies are on an unsustainable path, and the development of a credible medium-term plan for controlling deficits should be a high priority. At the same time, fiscal decisions should take into account the fragility of the recovery. That recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken.

This is the same gobbledegook that the IMF is going on with at the moment. We hear about “growth supporting austerity” from the IMF.

Two points can be made. First, you immediately see that Bernanke is part of the problem when he helps perpetuate the myths that fiscal policies are on “an unsustainable path”. Where is the evidence that the US economy will run out of real resources to bring into production in the foreseeable future?

The numbers on spreadsheets that the US Congressional Budget Office pump out don’t tell us anything about that. Bernanke, himself, recognises that there are massive unused productive resources in the US at present and millions of idle workers who want employment will remain frustrated beyond 2014.

Isn’t 2014 – the medium-term? So if there will be millions of American workers without work in 2014 and the S government has the capacity to purchase their services now, tomorrow and in 2014, how is fiscal policy on an unsustainable path?

Will the US government not be able to employ those workers in 2014? That would only be the case if the private sector was employing them and the US government wisely decided not to drive wage inflation by competing for their services. But in that event the problem is solved anyway – private spending would be up and net public spending would fall. End of story.

And how do we square Bernanke’s support for fiscal austerity in the Eurozone which is not only killing any real hope for a rapid recovery there but damaging the rest of the world including the US into the bargain?

Why should America “take into account the fragility of the economy” yet the Eurozone deliberately pursue policies that will make the economy even more fragile that it already is?

This is American logic – we need to cut spending but please don’t cut it where I live because spending cuts where I live will cause disastrous damage to the beauty salons, restaurants, car dealers, and the entire economy.

Of-course if you cut it elsewhere – it will still damage where I live – which is why European austerity is damaging the US.

Importantly, Ben Bernanke knows enough to realise that “if the full range of tax increases and spending cuts were allowed to take effect” (the fiscal cliff scenario) then:

… a shallow recession would occur early next year and about 1-1/4 million fewer jobs would be created in 2013.3 These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved.

The extent of the recession that will result is debatable. I think it will be more than shallow but then I don’t think nuances about words and degrees is the point. A recession is a disaster to an economy that would still be carrying 16 odd per cent underutilised labour as it entered it.

Recessions are economic events that should be avoided without exception. There is no saving grace from a recession.

But the interesting part of Ben Bernanke’s point here is that he is acknowledging what the Europeans and the British elites are attempting to deny – that spending cuts at a time when the economy is declining damage private sector confidence (introduce “additional negative effects”).

The fiscal contraction expansion myth – the Ricardian Equivalence myth – which underpins the stated claim that fiscal austerity will be good for growth because the private sector will be revitalised by the boost in confidence that comes from knowing that the budget deficit is being cut – denies basic human psychology.

Those Virginians know a thing or two. They know that public spending cuts in their neck of the woods will impact directly on jobs and have spill-over effects on those beauty salons, restaurants, car dealers – and finally – the entire economy. They are not claiming that private confidence will be boosted by the cuts – exactly the opposite.

It is obvious that spending growth is needed to restore overall economic growth in the US (and elsewhere). So the debate is about where that spending growth will come from.

At last count there were two broad macroeconomic sectors – the government and the non-government. The non-government sector can be decomposed into the private domestic sector and the external sector. The private domestic sector can be further decomposed into households who consume and firms who invest (in productive capital).

Macroeconomics is easy – thats it! 2 broad spending sectors and then some more detail.

What do we know about these sectors? The US Federal Reserve governor really said it all.

1. Households are not spending enough on consumption – and why should they given they have to reduce their unsustainable debt levels and are saving to generate buffers just in case they are next to join the unemployment queue.

2. Business firms are not spending enough on investment – and why should they given they have to reduce their unsustainable debt levels and that household spending is not pushing production levels beyond existing capacity (by a long margin).

3. The external sector is deteriorating – that is, spending is contracting because the Europeans and the Brits are killing growth in their economies.

Quick quiz question: How many more spending sectors are left in the US?

The most basic macroeconomic rule – spending equals income. When someone spends another gains income. When a sector increases spending, other sectors enjoy the rise in income.

So if all these non-government sector spenders are being cautious and the private domestic sector is attempting to save overall – and – the world economy is not going to drive US exports very hard – where is the deficit spending going to come from to drive growth?

Go to the top of the class and be qualified to write press releases for the Virginian political elite if you answered – government budget deficits.

A non-government surplus has to be matched by a public deficit – $-for-$. If income is declining as a result of private sector and external sector spending growth cuts then it has to be replaced by spending growth in the public sector.

Simple arithmetic – simple macroeconomics – a fundamental rule of a modern monetary system.

Conclusion

At some point this will all click in the minds of the voters who are being blinded by the crazy inconsistencies that come out of the mouths of their leaders and public officials.

The point is clear – everyone of them knows that public spending cuts will slow the economy. They all know that at this present time the slowdown will be disastrous.

But they also know the American people are pretty easily duped by conservative talk and religious invocation. And that is the way they plan to get power. What happens to the unemployed is just a side-issue.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.