Sunday, October 9, 2016

Government Spending Is Boosting Growth

Workers Building Humvee Undercarriage
A few months from now expect to see a slew of news stories about how spending by the Federal Government boosted the economy and the GDP in the third quarter. While doing a bit of manual labor the other day I was thinking about the economy and the continuing debate over the strength of the economy. I remembered that just prior to the last Presidential election the economy got a little boost and being a bit suspicious of the games Washington plays I'm forced to wonder how strong this has been in this cycle. On October 26th of 2012, I published the following article and added a footnote to it in early 2013.

        GDP up 2.0% because of Government spending

The GDP came out this morning, up 2.0% rather than the 1.8% that was expected. This is still very slow growth. What should be noted is that Government spending on defense outlays jumped 3.7%, the biggest increase since mid-2009. In all spending by the Federal Government was up a whopping 9.6%, this was responsible for the growth. Again this economy is being held up by the government, strange timing right before the election?

Another thing that should be called to our attention is inflation is again approaching the 3% area. With consumer spending around 2%, we still see no real growth. Business investment outside the residential sector fell 1.3%, the biggest drop since late 2009. Disposable income moved up 2.6%, but that was down from a 3.8% increase in the second quarter. The personal savings rate fell to 3.7% from 4.0%. A celebration is not in order.

FOOTNOTE; entered mid-January, 2013-------- Now that the holiday retail sales have been weighed and measured, they have come up short. Rolling into the fall many called for the best retail sales ever and imagined increases of around 5%.  After quietly tamping down their expectations, just yesterday it came out that sales beat expectations, with a gain of 0.3% excluding auto. This is pretty sad when you factor in inflation. I do love the way the media can spin a story.

Economy pumping is not an uncommon practice before an election but it is important we factor in its influence when attempting to determine the true strength of the economy. We should be careful not to allow GDP pumping to skew our vision as to where the economy is really headed what we really need is a catalyst or spark that builds upon itself to carry us forward and sadly, none have materialized while others such as auto sales have reached a peak. It has become clear that low-interest rates and central banks pumping money into the system can carry the economy only so far. Both these policies carry side-effects that can come back and haunt us such as encouraging over-leverage and poor allocation of capital. Today we are mired in slow growth for as far as the eye can see.

Capital is being poorly allocated and markets being distorted with money flowing into risky assets in search of higher yields. Over the last few years, many large companies have cut their workforce and replaced higher paid workers with lower paid employees. We have also seen production continuing to be outsourced to offshore factories to increase profits. In some cases where margins have been squeezed stock buybacks and cost cutting have been the only driver of higher profits. This has occurred as sales have been propelled forward by cheap money rather than by real or pent up demand. Sadly, it is year after year of massive government deficits that are also a driving us forward and propping up spending. The puzzle we now face is how this will play out going forward and what constitutes a reasonable expectation for future growth.

Slow Growth And Growing Debt!
America continues to rack up a deficit each year of nearly $2,500 for every man woman and child in the country, such deficits were unheard of in the past unless it was during a major war. Deficit spending has been accomplished by borrowing money that will become a long-term drag on the economy going forward. To make matters worse much of this money has been poorly spent, it was to be used to buy us time in which to address many of the structural problems that plague our economic future. Unfortunately, this has not been done, instead, the government has fiddled away the time in deadlock. Even the tailwind of lower energy cost through the massive expansion of oil and natural gas supplies has not been enough to move the economy forward. Much of what we have seen should be considered a one off that is behind us. Bottom-line all this trickles down to job growth, and it could be argued this is nothing to brag about because the jobs being created are not "quality" or even full-time jobs.

While many people feel the tremors that ran through the economy during the 2008 financial crisis cleansed the system the manner in which central bankers and politicians addressed the problems did little to resolve the key drivers that created them. A strong case can be made that the economy is about to be tested and encounter strong headwinds that will result in a major reset. Expect the burden of past debts and future promises made to those retiring to grow and weigh heavily upon society. Tensions have become elevated in many parts of the world as ISIS continues its campaign of terror causing a flood of refugees to flee war-torn areas. We cannot rule out the possibility that a major war is not on the horizon. It is clear the world is rapidly changing and nobody has a crystal ball predicting how this will all play out, but one thing is certain, and that is storm clouds do exist. This leaves the possibility that at any time the markets could morph into a "realizing market" grinding slowly downward or that at some point the wisdom of buying every pullback might change and the market simply drops like a stone.

Speculation based on mere hope is not a solution to our complex problems, silly talk that Washington has the deficit under control ignores reality. How America and countries across the world react to the stress that comes from slow economic growth and how it will affect our budget and culture as the long-term cost burden of carrying the unemployed builds has yet to be determined. However, the logic and motives of those forecasting a bright and robust economy need to be scrutinized. The reality is our America's future cannot be sustained on just the exports of Boeing aircraft, the manufacture of some kind of computer tablet, or internet usage. We need to look at more substantial and broader based benchmarks. It is not realistic to think the American consumer can continue to support exporting countries like China and Japan by racking up a 600 billion trade deficit year after year.

Footnote;  It is no secret that Washington tends to spin the news, they tell us the deficit is under control and all is well. Fact is the leap from 18 to 19 trillion in government didn't take long. Many people have looked away but the National Debt Clock has not stopped ticking and today it has solidly passed the 19 trillion dollar threshold by 647 billion dollars.
One thing is crystal clear, it is far easier to run up debt than to pay it off. The truth is in 2017 entitlements are poised to balloon causing a massive spike in government spending. More on the true numbers and this growing problem below.

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