The Stimulus and Fear

Posted: Apr 06, 2012 12:01 AM

We haven’t had too much fear in the market this year. However, if you bought in November, you might be feeling a little bit greedy. With the Fed saying it’s on hold until the end of 2014, a lot of folks queued up bets for a little more QE. It’s also an election year, and many are closely watching the polls.

Yesterday, the hopes and dreams of the QE players started to seep out of the market. From current polls, it looks like the Republicans will control the House and Senate and the Presidential race is going to be very close.

Because we haven’t exactly had a traditional recovery from our last recession, a lot of folks are fearful of what will happen when the Fed stops printing money and our government stops spending it. That is what is driving the latest sell offs of markets in Europe.

Short term, cutting government spending will not be accretive to GDP. Government spending is like heroin. Initially it feels good and doesn’t cost much. After awhile, you build up tolerance and you begin doing anything to get the drug to feel good again. Too much reliance on government spending, and eventually economies die. No one works. GDP shrivels.

In the long term cutting government spending is good for economic growth. Competition for growth capital between private industry and government ends. Government gets out of the business of running things and private industry takes over. Private companies are always more efficient and responsive than government. Always.

Of course, this assumes that the Republicans are serious about going forward with an economic agenda first, and not muddying the waters with a bunch of social issues stuff. Think of it as the difference between the way Paul Ryan speaks, and the way Rick Santorum speaks. Ryan leads with budget issues, and if you want to talk about social issues it’s in the back of his notes. Santorum leads with divisive social issues, and might get around to talking about real economics if pushed. When one is struggling to put food on the table, they don’t give a rats ass about social issues. That’s for elites.

Given the debacle that happened financially in the US from 2000-2012, I think most of the Republicans have their “financial” hat on. If they don’t, they will lose relevance as a political party.

In the classical economic model, government spending only makes up about 10% of the make up of GDP. Growth depends on the consumer, and business. If we look at the New Deal programs, and all the other government programs that rise in spending every year, their train is arriving at the Day of Reckoning Station. Demographically and morally, we can’t afford them. It’s time to change them to adapt to modern finance, or get rid of them entirely and let private industry take over.

Here is what the US looks like graphically.
US Federal Government Current Receipts Chart

US Federal Government Current Receipts data by YCharts

The percentage of US spending as it relates to GDP is down because, GDP is down….and the Republicans took control of the House in 2010 putting the brakes on runaway spending.

The auctions for European debt have startled investors from their bullish slumber. Interest rates are on the rise again after a few months of tepidness.

In my opinion, the Europeans are fixing their budgets incorrectly. Sure, they should be slashing government spending. But they shouldn’t be raising taxes at the same time! That’s a double whammy against growth. Higher taxes will not bring in more revenue because individuals and businesses will change behavior to avoid the tax.

What government should do is cut spending, and cut taxes at the same time. Accountants will tell you that this will be absolutely tragic for a government budget. Classical economists will disagree and tell you that an economy is going to grow. Gross government revenue will grow along with it. The wheels of private industry will turn and everyone will become more productive.

At the same time governments cut spending, they need to cut the size and scope of regulation too. Few places in the world are as regulated as the Western European Socialist states. It’s almost impossible to start and grow a business there. Many of them have real unemployment in the high teens or even over 20%.

The US should not follow Europe’s lead. Though in 2013 we might. Depending on the outcome of the elections, we could actually cut government spending, and have huge tax increases. It won’t be until November 7, 2012 that we have some certainty to the future of US fiscal policy.

Follow me on Twitter