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The Day The World Said No
Finance
Perspective on the News
Monday, June 28, 2010
Ed DeShields

The world’s developed nations handed President Obama a big thumbs down to his economic views this week at the G20 summit in Toronto.  The president lost his case that printing, borrowing and government stimulus is necessary when other countries decided this is not a direction that makes sense.

Consequently, a reluctant Obama administration announced that they will go along with other leaders who are more concerned about rising debt and join in a commitment to cut government deficits in half by 2013.

Folks, think of Obama and what he stands for.  This is just not going to happen. 

The G20 plan calls for the U.S. to cut our budget deficit to only 3% of GDP by 2013.  It is now sitting at 10%.  This means a decline from a $1.4 trillion deficit to a roughly $420 billion deficit, or ~$1 trillion in cuts would be necessary in just three years.

One path to getting the deficit down is to cut spending. However, government spending is a big part of GDP so cutting spending shrinks the GDP.  The more spending is cut the more GDP shrinks which makes the deficit ratio less favorable. And, because government income expands and shrinks in proportion to GDP, when you cut spending it actually leads to reduced government income which leads to higher deficits which lead to more cutting which results in an endless spiral into disaster.

Obama’s path consists of more government borrowing and spending done with the hope that eventually our economy expands and our GDP climbs over time and lowers the ratio of deficit-to-GDP.  The Obama administration sees this as the only viable option but Europe has figured out that this path too has its own end-game which is the eventual collapse of sovereign debt and the high likelihood of associated political and social chaos.

Neither option is attractive.  One is an endless downward spiral into bankruptcy, the other a collapse of sovereign debt and social chaos.  Both are very painful to citizens.

Remember that $1 trillion in cuts we must make?  Cutting a trillion in federal spending would cut 7% from the GDP and even if we were willing to take a 7% hit to GDP, where would the trillion come from?  Much of the US deficit is now structural meaning it sits in the “mandatory” column as opposed to the “discretionary” column. 

Finding $1 trillion is simply not going to happen if the only part of the budget that can be controlled is both discretionary and politically viable in an election year which totals only $447 billion. You can’t squeeze blood from a turnip and you can't save a trillion from a budget of less than half a trillion. But that’s only part of the problem.

The U.S. will tell the G20 it agrees to the plan but will not honor its promise.

Not during an election year.

And, probably not next year either. 

And. probably not ever unless forced by another crisis because the political class in the U.S. seems unable to get their heads around the idea that there are limits to everything;  limits like how much we can spend and consume in this world where everything is finite. 

Leading up to the G20 summit, the president’s budget director, Peter Orszag, pleaded for the U.S. to begin to live within its economic means.  Yet, the president wants to print and spend to achieve his political aims.  Mr. Orszag, a real budget wonk, believes this path represents the eventual and probable catastrophic bankruptcy of the U.S. 

Rather than continue to fight a losing cause with the “print now, pay later” club, Mr. Orszag said no, and resigned.

And, the rest of the world soon followed suit, and said no.   

About Ed DeShields

Last week: When Rear Ends Need Kicking



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