Tuesday, June 29, 2010

G-20 Pledge To Cut Deficits/Debt Will Have Multiple Consequences

Investors fear that the Group of 20's pledge to cut deficits could hurt global growth.

The stock market is tumbling.

Investors are concerned that a pledge by G-20 nations to halve their deficits by 2013 and stabilize their debt by 2016 sends the message that the days of endless stimulus are over.

G-20 countries set "goals" to cut their deficits in half by 2013 and to "stabilize or reduce" debt-to-GDP ratios by 2016. Given the state of the global economy, that seems unlikely. But should they follow through on this pledge, it will undoubtedly slow the global economy.

That's what you call a catch-22, or being caught between a rock and a hard place.

Governments are faced with a couple of ugly choices, Absent government stimulus and deficit spending, they face stagnating economies due to lowered demand, which will lead to layoffs and slower job creation.

To avoid that, they can continue to spend heavily, running up greater deficits and debts. However, that will hurt their fiscal position and likely lead to demands of higher interest rates on the bond markets.

To complicate things even further, a nation cannot pay off its massive debts without achieving strong economic growth.

Greece is the perfect model of what can happen when government spending, deficits and debt get out of control. Who wants to buy the bonds of a nation that may not be able to pay you back?

The Obama administration said Sunday that it will work to reduce the U.S. fiscal deficit to 3% of GDP by 2015.

The problem is that the private sector isn't nearly robust enough to sustain the economy on its own. In fact, multiple indicators show that the economy is faltering. Without growth, there are no jobs. And without jobs, there can be no meaningful, sustainable, recovery.

American consumers see the signs and they are rightfully worried.

The consumer confidence index plummeted to 52.9 in June - the lowest level since March -- from a downwardly revised 62.7 in May. That's a huge drop. A reading above 90 indicates the economy is on solid footing; above 100 signals strong growth. By this measure, we are a long way from recovery.

There appear to be limits to how much the federal government can help. The stimulus money from last year is drying up and first quarter GDP came in at a disappointing 2.7%. Early indicators show that the second quarter could be even worse.

We're in a vicious cycle; no growth, no jobs, no recovery.

Growth would need to equal 5% for all of 2010 just to lower the average jobless rate for the year by 1 percentage point. Clearly, that is not going to happen.

How will Americans respond when the government eventually begins cutting the budget and eliminating spending for popular programs?

Europeans are letting their opinions be heard loud and clear; Greece and Spain have been beset with protests and labor strikes.

Major cuts have already begun in states across the US.

Last week, the Senate shot down a bill that would have extended unemployment benefits yet again. Congress had previously extended benefits four times since 2008.

Aside from affecting nearly a million unemployed Americans, the decision will also deny states billions of dollars in financial assistance, leading to even more draconian budget cuts.

That will in turn create even more pressure on GDP, undoubtedly shrinking it. The economy will contract if consumers and governments aren't active. Someone has to spend.

The denial of unemployment benefits will also create a drag on economic growth. Millions of Americans will no longer be pumping that money back into the economy.

As I've said repeatedly, there are no good answers; only very difficult choices. We have entered a debt trap that presents an enormous conundrum; do we continue to mortgage our nation's future by becoming even more grossly indebted? Or, do we show fiscal restraint and suffer the consequences of another possible depression?

These are the hard and nasty choices we face as a nation.

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