Shutdown economics 101: Kudlow versus Reich (Part 4 of 10)
Exploding US debt: Going to Vegas, or garden-variety Keynesianism?
The below graph reflects the doubling of publicly held debt under the Obama Administration from roughly 35% to 70% of gross domestic product. However, it also reflects the doubling of publicly held debt under the Reagan Bush Administrations from 1981 to 1993. Given the severity of the 2008 financial crisis, the Obama Administration has doubled the debt in four years, while the Republicans required 12 years to attain the same level of achievement, reflecting a certain tendency toward underachievement on behalf of the prior Republican Administrations (at least as far as deficit spending is concerned). This article considers the rapid growth of US debt, implications of continuing to grow the deficit as a means of ending the current economic crisis, and the potential impact on US equity markets.
Krugman on debt
Paul Krugman suggests that US Government debt isn’t that important:
- “…it’s not that we as a Nation have overspent and need to spend less; it’s that some people are being forced to spend less, and we have a depression because other people won’t (NOT can’t) spend more. This is how you need to think about debt; it’s not a burden on the Nation’s resources, because its mainly money we owe to ourselves, and it’s a problem not because we have to tighten our belt, but because debt is currently leading to spending that’s less than we need to maintain full employment.”
Whose misadventured piteous overthrows…
While Krugman tends to see the debt as less of a problem, it would appear that most of the Republican Party, and probably the entire Tea Party, would disagree. Economists might be somewhat dismissive of the growth in US debt, as the debt is partially offset by record corporate profits and increased savings—described in Part 8 of this series. While corporate profits are extremely high relative to fixed investment, the overall change in national savings post-2008 is still quite small. From 1980 to 2008, the national savings rate was 16.64% of GDP, though it has fallen to 12.40% of GDP from 2008 through 2012. Personal consumption remains near record highs at nearly 70% of GDP, while national savings have bounced from 11% to 13% since the crisis—2009 through 2012. It would appear that savings and investment would have to grow much more substantially in relation to consumption in order for the US to get the debt growth under control. Given record profits in the US, it might be reasonable to expect more positive investment data in the future, though the savings rate remains quite anemic.
However, the media has a different spin on these economic concerns, and there seems to be a large degree of fear-mongering on both sides of the aisle in Washington. This draws attention to a bad snapshot of present economic data. Perhaps the media coverage doesn’t grant due consideration to how free market forces have the ability, and perhaps tendency, to gradually rectify near-term imbalances in savings, investment, and consumption relative to overall debt levels. As the above graph illustrates, the US has in fact seen dramatic declines in debt as a result of tax cuts, as had occurred quite dramatically during the Clinton Administration, falling from 50% to nearly 30% of GDP. That’s a big drop.
As a result, the average evening news viewer is left wondering if the entire debt debate is anything more than a pitiable misadventure in economic punditry, founded in the same academic rigor as unbridled trickle-down theory. So the public may not be fully persuaded that the debt is in fact as God-awfully important as the Republicans make it out to be. Perhaps even the Democrats believe that free market capitalism, with proper regulation, can in fact deliver exceptional economic growth results—debt ceiling be damned. Regulation and tax policy are clearly the bones of contention within this somewhat ambiguous academic debate on the importance of current US debt levels. Are current debt levels really that bad?
Reich’s Davy Crockett cap
While Reich would agree that deal making is necessary in Washington, it would appear that the Democratic Party, including Robert Reich, won’t let go of their hard-won idol, Obamacare. In a recent article, Robert Reich points out that, as a child, bullies had forced him to concede the change in his pocket, the dessert in his lunchbox, his softball, his baseball bat—and finally, the indignity of all indignities—his Davy Crokett cap. However, Reich will be damned if he’s going to give up Obamacare to the Republican bullies.
Kudlow’s debt cap
While Larry Kudlow worked at the Office of Management and Budget (or OMB) during Reagan’s first term (the ketchup-as-vegetable term), from 1981 to 1985, he learned a thing or two about how budgets are made in partnership with the Congressional Budget Office (or CBO). As Larry Kudlow has pointed out in his show on CNBC, there appears to be a lack of good old-fashioned horse trading in Washington. Reagan did it with Democrat Tip O’Neill during the Reagan Administration, and Obama simply needs to follow form and do the same with current House Speaker Republican John Boehner. What was simply good for the Republican goose is now good for the Democratic gander. Kudlow almost implies that, with enough horse trading, there’s room for both a debt cap and Obamacare. (However, if Robert Reich wants his Davy Crockett cap, Obamacare, he had better give Larry and the Republicans the dessert in his lunchbox, the debt cap).
Shutdown investing: Outlook
Should Congress and the President fail to make progress on budget discussions, investors may wish to consider limiting excessive exposure to the US domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM). Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples–related shares, as reflected in the iShares Russell 1000 Value Index (IWD). Plus, even the global blue chip shares in the S&P 500 or Dow Jones could come under pressure in a rising interest rate environment accompanied by sequester-driven declines in consumption, investment, and economic growth. So investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY), Blackrock iShares S&P 500 Index (IVV), or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs. Until consumption, investment, and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution, and consider value and defensive sectors for investment.
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