Will Gov’t Debt, Weak Growth Lead to Global Recession in 2012?

Hoisington Investment Management has released another quarterly economic forecast. And like, Gary Shilling earlier this month, they believe we’re headed for a bumpy road in 2012. Van Hoisington and Lacy Hunt, who co-wrote the report released this week, believe the stratospheric government debt will lead to lower economic growth, and that the European debt crisis will sharply curtail U.S. exports.  

From Hoisington Management:

It would be difficult to devise a more horrendous set of fiscal policy parameters to spur economic growth than currently exist. Real federal government purchases of goods and services, which comprise 8% of real GDP, will decline by about 1% if the impartial projection of the Congressional Budget Office (CBO) for a fiscal 2012 deficit of about $1.3 trillion is in the ballpark. Defense spending will bear most of the decline in federal expenditures, but non-defense spending will, at best, be flat. In spite of record deficits since the spring quarter of 2009, real federal government purchases of goods and services have risen at an anemic 1.5% annual rate, confirmation that only a small amount of exploding expenditures went for infrastructure projects. The scant growth rate in the economy suggests a negative outlay multiplier.

 

Contrary to common belief, the massive deficits of recent years will actually reduce economic growth in 2012 through a subtle, but nevertheless credible channel consistent with the preponderance of economic research. Studies suggest the government expenditure multiplier is zero to slightly negative. Increased deficit spending does appear to provide a modest lift to GDP for three to five quarters, depending upon the initial conditions of the economy. However, following this small, transitory gain, deficit spending actually retards GDP growth and the economy returns to its starting point at the end of about twelve quarters. Based on our interpretation of these studies, the U.S. economy is now on the backside of the string of record deficits, and this will be a drag in 2012. Despite the massive spending, all that is left is an economy saddled with a higher level of debt, with more of its productive resources diverted to paying the non-productive elevated level of interest payments. According to the CBO, gross federal debt will rise to at least 103% by the end of 2013. However, if the FICA tax reduction is extended for the full year, and/or a recession ensues, as we expect, revenues and expenditure estimates by the CBO will prove to be too optimistic. Under current circumstances, no viable way exists to remove the increasing federal debt burden from the economy’s growth trajectory. As such, the federal fiscal constraint is operative for the foreseeable future.

Be sure to check out the full report to see some interesting charts.

It’s always entertaining to see how different economists view the debt situation. This week, Irwin Kellner, the chief economist at MarketWatch, made the case that a 100% debt-to-GDP ratio is no biggie, and at worst a necessary inconvenience as this point.
 
 
 
 
From Marketwatch:

While the government’s actual debt is projected to climb over the next five years, its size relative to the economy is expected to level off pretty much where it started 2012 — about 100%.

 

As you can see, the U.S. (and most other countries) is no stranger to annual budget deficits and their accumulated debt. That said, you have to wonder why all the fuss is being made today about deficits and debts — where were these antagonists in years past?

 

True, when it comes to debts, less is more. In other words — we should not be relying so much on borrowing as we have been doing. But as you also can see, most of these deficits were run under extenuating circumstances (wars, recessions, market crashes and the like).

 

With the economy still feeling the effects of the Great Recession, now is not the time for austerity; it will only make things worse. There are more effective ways to reduce deficits, such as faster growth.

 

In my view, faster growth is a win-win way to cut deficits, since it will boost sales, profits, and, of course, create jobs for the private sector, while generating more tax revenues and reducing the need for social spending by governments on all levels.

 

But as any business person will attest, you have to spend money to make money. Thus when it comes to reducing budget deficits, we need to tax less and spend more — not the other way around as the deficit-busters would have you believe.

So debt is either the end of the world, or the path to prosperity. Take your pick. Economists … what would we do without them?

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