Jack Rasmus

COMMENTARY: After being assured by politicians that the economic ceiling would fall in if the deficit wasn’t cut by trillions in order to raise the debt ceiling, business and the markets yawned with the passage of the deal. Was it perhaps not such a pending crisis as we were led to believe? It had similarities to 2008 and then Treasury Secretary Paulson demanding a $700 billion blank check to bail out the banks, or economic armageddon would quickly happen. But business and markets didn’t yawn at reports this week indicating a collapse of global manufacturing; or the plunge in consumer spending. They choked and then screamed. The real economy is accelerating its slide toward double dip, as this blog post argues, which was written earlier this week and appeared on the public site, Truthout.

‘America’s 4-D Economy: From Debt Deals to Double Dip’, by Jack Rasmus, copyright August 2011

With the debt ceiling agreement almost a certainty this past Sunday evening, the expectation was the markets and the economy would rebound briskly the following day. After all, werent we all bombarded for weeks with the message that if the debt ceiling were not raised, the economic sky would fall in? The economy would tank? Economic Armageddon was coming? So if we raised the debt ceiling, the markets would rebound, right?

On Monday the stock market at first did rebound on the news of the imminent debt deal, but only briefly and modestly. It quickly turned around within hours on Monday, declining sharply by the end of the day. Why? The debt deal in the bag by Monday. The recalcitrant House and Teapublicans voted for it. Only the formality of the Senate voting on Tuesday remained. Why wouldn’t the markets, falling most of previous week, snap back with the conclusion of the debt deal?

Instead the markets slumped badly by the close of business on Monday, not because of the debt deal but in response to a report late that morning showing the July U.S. manufacturing activity index had fallen to 50.9% in July from 55.3% in Junethe largest collapse in years and to the lowest level since June 2009 which was the trough of the recent recession. 50% for the manufacturing index represents no growth. That’s stagnation. Even more serious, in the report future orders for manufactured goods fell to 49.2%–a clear contraction–the first such since June 2009 as well. In other words, in terms of manufacturing at least, the economy now was right back where it was two years ago.

No wonder the stock market shuddered on Monday, notwithstanding all the good news about the debt deal. The performance of the real economy was far more important and real than all the huff and puff about debt ceilings and defaults by the US government. The alleged good news of the debt agreement was overwhelmed by the indisputable real news the real economy was heading for a relapse.

And it was not just the US economy. Not reported by the US press on Monday was that the US manufacturing indexs nearly 5% points drop was being echoed at the same time by a decline in global manufacturing–in Europe, UK, Asia, even China. All reportedly had begun to slip.

On Tuesday the debt ceiling deal was voted up by the Senate and signed by Obama into law. But the New York Stock Exchange fell by another 265 points and the Nasdaq by a whopping 75. Wait a minute! The debt deal was officially done, wasn’t it? No chance of a reversal. So why did the markets finally respond so negatively? The real reason was a further report on Tuesday. Consumer spending–representing 70% of the economy–fell by 0.2%, the first drop since September 2009.

In the face of this evidence of immanent contraction of the US economy, Congress voted to cut deficits in the amount to $1 trillion for certain, with another minimum $1.2 trillion minimum in spending reductions due before the year end. Granted, much of that $2.2 trillion will be spread over ten years. But there will be about $30 billion in immediate cuts this year from the initial $1 trillion deficit reduction. Most of that will come from education. And still more, and bigger, first year spending cuts before year end.

The second round of $1.2 trillion in cuts will likely equal at least another $50-$100 billion in the short term, most of that from Medicare-Medicaid and a lesser, token amount from Defense, this writer predicts. That’s about $100 billion in total federal government spending cuts impacting the economy this coming year. Add to that the $38 billion cuts in spending enacted last spring in revisions to the 2011 budget, plus another $100 billion spending cuts forcasted by state and local governments the coming first year, and what you get is around $250 billion in spending reductions for the coming year.

But this $250 billions impact must be multiplied to get its true, final economic effect. Economists estimate the multiplier from government spending at about 1.5. That means for every $1 cut in government spending, about $1.5 dollars are taken out of the economy. The first year of cuts are therefore $375-$400 billion in terms of their economic effect. Ironically, that’s about equal to the spending increase from Obama’s 2009 initial stimulus package. In other words, we are about to extract from the economy, now showing multiple signs of weakening badly, the original spending stimulus of 2009!

As others have pointed out, that magnitude of spending contraction will result in 1.5 to 2 million more jobs lost. That’s also about all the jobs created since the trough of the recession in June 2009. In other words, the jobs markets will be thrown back two years as well.

With the debt ceiling deal, the US Congress and President have crossed the bridge into parched desert of austerity. This is an historic juncture, shifting from stimulus to grow the economy out of recession to austerity to thrust it back into recession! But the politicians of both parties are due for a rude surprise. Deficit cutting and austerity will result in worsening deficits and more debt, not reductions in deficits. An economy cannot cut its way out of a deficit and recession any more than a company can cut its way back to long run profitability. It can only grow its way out by generating more revenue. For a company, that means selling more products and sales revenue; for the economy that means creating more jobs and raising tax revenue.

Austerity solutions are a dead end. If anyone believes austerity solutions are the answer to recovery, they should simply look at Greece, Ireland, and the rest of the periphery of the Eurozone. Imposing austerity there has resulted in a further deepening recession, falling tax revenues, and still worsening deficits and debt. Ditto for the conservatives in the United Kingdom, whose recent deficit cutting is now thrusting that economy back into recession. The same is inevitable for the U.S. if it continues toward austerity, deficit and spending reductions, as a way to recovery. To employ a metaphor, austerity is like trying to win a race by shooting yourself in the foot at the starting block.

Nevertheless, it appears more austerity is on the agenda in the U: the next round in the 2012 budget negotiations due by October 1; further in the December cuts that will be mandated by the so-called Bipartisan Committee; and following that still more cuts, this writer predicts, in 2012, as the recession wipes out a good part of the prior spending cuts.

More cuts will follow because, despite the deficit cutting, the US budget deficit will now actually worsen and not improve. As the economy slides, tax revenues will fall below those officially projected, generating a call for even more cuts from those who believe deficit and debt reduction will restore business confidence and therefore investment and recovery.

All the talk about restoring business confidence is, in other words, simply a confidence game. Collapsing business confidence is a consequence not of deficit cutting but of consumers being unable to afford to buy their products. Want to change business confidence? Help consumers buy their products and see how fast that confidence returns. Adding 2 million more to the total jobless will only reduce consumers income further, exacerbate the decline in consumption already underway, and result in turn in a further deterioration of business confidence.

The past few days the US economy has been dealt several severe blows in the reports on manufacturing decline and consumers retreat. A one-two punch. Over time the realization will grow that the deficit cuts–$1 trillion now and another $1.2 trillion in a couple months will do great harm to the economy. The cuts represent another major body blow to the economy that is already rapidly weakening. The markets know this. Business confidence knows this. Apparently only the politicians don’t.

And more is yet to come. On Friday the jobs report for July is due for release. July and August employment reports will show even more clearly the serious extent of the economic slide now underway. The coming jobs reports could prove a knock-out blow to the economy. The big money investors are already betting on that outcome. Dump your stocks and stuff your closet with bonds! The recent debt ceiling debate, in retrospect, appears as just the opening act, with the amateurs (Congress and Obama) flailing at each other until finally exhausted and calling it a draw, returning to their respective corners to catch their breath. The main event is yet to come.

In early 2009 Obama implemented his economic stimulus and recovery plan. The Congress and US Treasury spent $2 trillion and the Federal Reserve more than $9 trillion to bail out the banks. What we got was the weakest and most lopsided recovery since 1940. After a brief twelve months the economy sagged again, last summer 2010. Followed by $600 billion more Fed stimulus, and $350 billion more tax stimulus at year end 2010, which included $250 billion in Bush tax cut extensions. The result? The economy slowed again, even more quickly, to less than 1.0% growth in GDP the first six months of 2011. The current third quarter, July-September 2011, will likely prove worse. Stepping into that ring are Congress and Obama. Double Dip recession will be their joint legacy. And if the banking system implodes in Europe, the outcomes will be even worse…much worse.

Jack Rasmus
August 2, 2011