WHAT ARE THE CONSEQUENCES OF FEDERAL BUDGET DECREASES

A key metric in how well our (U.S.) economy is doing is GDP (Gross Domestic Product). The formula for GDP is:

GDP = C + I + G + Net Exports , where C is consumption, I is investment, G is government spending, and Net Exports is total exports - total imports.

To get a positive GDP, Net Exports has always been negative since 1977 because of our insistence on importing so much oil so C+I+G must increase to make up for the Net Exports. The sum of these three almost always will more than make up for the negative Net Exports although the trade deficit can be significant ($695.9 billion in 2007*). Now there is a move to try to eliminate or at least reduce Government deficits or reduce G (i.e. government spending in the formula). Therefore, C+I must increase more than the reduction in G plus a negative Net Exports in order to achieve a positive GDP. The bigger the reduction in G, the more difficult it will be for C+I to turn GDP positive.

Recently congress passed and the president signed a bill to cut the 2011 Federal budget by $38.5 billion in the last five months of the fiscal year.** If all these budget cuts were to occur this fiscal year as many wanted, to have a positive GDP over this period means that C and I must increase by more than $38.5 billion during these five months. I confess I have no idea how easy it would be for C+I to do this; however, consumption under the present depressed economic environment, where median household income is declining, is unlikely to increase much. So it falls mainly on investment to increase by most of the $38.5 billion.

It turns out, however, that only about $385 million of the $38.5 billion will occur in Fiscal Year 2011, and I would expect the economy to easily handle that. But the rest of the cuts are real though they will occur in future years and spreading them out like that should make them easier to handle especially if the economy continues to recover from the Great Recession.

There will be attempts to make even larger cuts in the Federal budget in future years so the impacts on GDP will be larger if they are instituted. Actually, the best time to cut the Federal budget significantly is during a rapidly rising economy when both C and I are rapidly increasing and not, as now, during a slow recovery from a Great Recession. Yes, declining G will lower the GDP by some amount during a rapidly expanding economy depending on the size of the Federal budget reduction and on how fast C+I are increasing.

I suspect that most people who want large budget cuts NOW (including nearly all "tea partiers" it would seem), do not understand the equation for GDP. There are those, however, that do (e.g. John Mauldin). With them, they feel that cutting the Federal budget will give a morale boost and help the economy. More specifically the expectation is that Federal borrowing drives out private sector borrowing because there is only so much money. This claim is faulty, however, in that no one forces industry to buy Treasury bonds, notes or bills. If they are doing it, it is because the don't know of anything better to do with the money and want to park it somewhere safe. In addition, the wealthy do not invest much of their money on productive things in America but put a lot of it voluntarily into government bonds (not all American Treasuries) and "... goes to things that may benefit the global economy but have no or little benefit to the U.S. - such as purchasing chalets in Switzerland, Canadian bombardier personal jets, islands in the Bahamas, and the like.*** As the amount of Treasuries are reduced, the wealthy will probably still buy them in their usual amounts because they want to put most of their money into safe securities rather than taking on more risk, though this may drive up the price of the bonds.

The point is that if reductions in the Federal budget are instituted too rapidly, investment and consumption may not be able to keep up and therefore plunge our GDP into negative numbers, thus creating a recession or worse. Our best hope is that the current economic recovery continues and even accelerates which would even make the size of the Federal budget reductions more manageable. After all, Federal revenues are the lowest they have been in 60 years.

* http://en.wikipedia.org/wiki/Economy_of_the_United_States

** http://stopcontinentaldrift.blogspot.com/2011/04/385-billion-is-lot-of-money.html

*** http://stopcontinentaldrift.blogspot.com/2010/05/effectiveness-of-taxes.html

ZÜRICH: THE FIRST DAYS (Biography)

On October 1, 1968, we finally arrived in Zürich by airplane, very delayed, where we were to stay for a year. Our Pan American* flight that was supposed to land in Zürich experienced engine trouble half way over the Atlantic and decided to make an emergency landing in London. Then the mess began as there was no flight to Zürich in any reasonable time. After a long period of enquiry, it was decided that we should fly to Hamburg, Germany, where there were lots of flights to our destination. So we got to Hamburg where the clerk at the reservations counter looked at our tickets and said, “Why are you here?” Of course we had to tell the whole story. He did get us on a very nice and efficient flight to Zürich on the German Lufthansa Airlines. I called my friend Prof. Dr. Marc Grünenfelder to come and rescue us, which in due time he did.

On the drive to our apartment on the Niederdorfstrasse off of Hirschen Platz, I was disappointed to see a rather Medieval city and not chalets with loads of geraniums. Our apartment building fit the reality, made out of brick. As we moved into our apartment building, I noticed an aroma that reminded me of Japan, the only other foreign country I had been to other than an evening in Juarez, Mexico. After Marc left, we got a bit organized, and I decided to go up to the ETH (The official translation is the Swiss Federal Institute of Technology.). On the way up I noticed some nicely dressed ladies waiting for taxies. I made it up to the ETH by climbing the stairs up a high cliff. There was a building under construction, and I was shocked to see a workman up on high iron drinking from a large bottle of beer. I visited with my fellow scientists for an hour or two and returned to the apartment. On the way down these nicely dressed ladies were still waiting for taxies, and I thought, "Boy, taxi service must be awful here." It turns out that the Niederdorfstrasse is the “sin city” of Zürich. OK, I'm afraid I was very prudish and naive, and the ladies were “the ladies of the night.” It apparently showed because we lived on the Niederdorfstrasse for five months, and I was never propositioned. Finally on the last day before we left Zurich, my wife and I were walking down the Niederdorstrasse on a Sunday for one last time and a young lady did proposition me, right in front of my wife. I wonder if someone put her up to it?

As I returned to our apartment, again I smelled the aroma I associated with Japan. I thought it just must be that I was in a foreign country and assumed the aromas were Japanese. It turned out, however, that there was a Chinese restaurant on the floor below our apartment that was the source of the aromas.

Our apartment was curious in that the “kitchen” was in the bathroom. There was a two burner hotplate on top of a counter with a tiny refrigerator over the bidet. The apartment, it turns out, was a converted hotel room.

We decided to eat out and went in search of a restaurant. There were quite a few, and the one we selected was the Swartzer Adler where I was introduced to the Swiss dish of geschnetzeltes kalbsfleish, strips of veal in a cream sauce with mushrooms and white wine. I also had some of the pear brandy that was very good. It was an excellent beginning.

The next night we were invited to a party and people would ask where we were staying. When we would tell them, they would say, “I hope you are not walking around there at night.” They seemed to think that half the people walking there at night were knifed and the other half beat up. However, in our five months living there we saw no such event or holdups. The worst I saw was one drunk push another in a parade for the Fasnacht carnival. In fact the worst sin we experienced there was the men coming out of the bars at midnight closing and banging on the garbage cans. Then they would do this again when leaving the “ladies” rooms at about 1:00 AM. The church bells of Praediger Kirche on Hirschen Platz would ring at 6:00 AM. Getting adequate sleep was difficult. To avoid all this night noise, we eventually moved after five months.

* I always seemed to experience trouble of some sort going at least one way on Pan American Airways so that I nicknamed it The Pits Airline.

$38.5 BILLION IS A LOT OF MONEY

Apparently from the result Friday night (8April 2011), the Federal government is to be spared a partial shutdown. Though the details are yet to be spelled out, it appears that $38.5 billion is to be taken out of the American economy over the next five months. It is not possible to tell just what the impacts of this will be, but $38.5 billion is equivalent to the income of 770,000 median income HOUSEHOLDS in America (a bit less than $50,000 each).* If our economic recovery was raging, the effects might be relatively little. Whether the cuts are sufficient to put our fragile economy into some sort of recession is not known to me, but the economic impact of "austerity" in Britain and France seems to be having a negative impact.

Much as some people like to pretend, the Federal government does not just take $38.5 billion out and make a bonfire of it. It goes out in salaries, contracts and benefits throughout America. Just how many thousands of people are going to be fired (both Civil Servants and contractees), how many thousands of contracts are to be terminated and broken, and the extent of reduced benefits are yet to be determined. In addition, just how many social strictures are still buried in the bill are not yet known.

For several years now, I have had this lingering suspicion that I have lived through the best of American history, at least for the middle and poor classes. If we really are going to try to reduce the Federal budget by something like $1.5 trillion to match Federal revenues, I can't see how that can be done without causing a deep recession or depression for the poor and middle classes. Other examples, the median household income has been declining in recent years, and we have insisted on running up a trade deficit for 34 consecutive years with no end in sight. On the other hand, I have always projected disaster and very little of it has occurred. So I can only hope there is some way out of our current predicament, even though I certainly can't see how. A bubble economy might do it, but is one in sight?

* President Clinton got rid of roughly this number of employees when he was President, a record, with seemingly little impact on the economy; however, that was at a time of strong economic, even bubble, economic growth so whatever the Federal government took out of the economy was replaced and then some by the private sector plus by state and local government increases (State and local government employment is being reduced as well.). Such is not the case today though there seems to be a nice recovery developing to some unknown extent by so-called quantitative easing (QE). Federal revenues are at 60 yr lows, so the economy has a long way to go to save the American lifestyle as we know it if we are going to try to balance the budget or even come close to doing so.

NORTH CAROLINA IN APRIL (DOGWOOD)

NORTH CAROLINA IN APRIL (Wisteria) [The plant was destroyed in road widening.]

SOME THOUGHTS ON DECREASING THE FEDERAL BUDGET

There is the thought expressed by many that decreasing the Federal buget will decrease Federal borrowing and free up money for the private sector. But nobody is forced to buy government bonds, notes or bills (government securites). They do it of their own accord because Federal government vehicles are thought to be safe. So it really doesn't follow that the people that buy government securities will switch to buying less-safe private sector securites (stocks, bonds, etc.). More likely, it seems to me, that the people or companies that buy government securites will continue to buy them. If the securites become more rare, this continued demand will just bid up the price of the government securities. For example, with corporations, the only reason they will buy Federal government securities is that they don't know of any other place to invest the money profitably so want to park the money in some safe place depending on developments. The wealthy buy government securites because they are safe and not susceptible to state and local taxes. There are various reasons that foreign countries (like China) buy U.S. government securities, but certainly one component is safety. As far as balance of payments shortcomings are concerned, the foreign countries could buy private assets in the U.S. such as stock and property and some of this is done. But buying government securities do not conflict with buying private securities.