U.S. annualized real GDP growth of 1.2% through Q3 2011 was driven by personal consumption, accounting for 91% of it.  Yet only 44% of personal consumption growth was driven by higher incomes.  The other 56% was accounted for by unsustainable items: a decline in savings (36%) and the payroll tax cut (20%).  The latter will expire in two months time unless Congress acts to extend it again. Read more »

“It is time for a breakthrough to a new Europe,” German Chancellor Angela Merkel said on November 9th.  “That will mean more Europe, not less.” Merkel wants a stronger fiscal union with strict controls on eurozone national budgets.  Yet to date EU fiscal policy, such as it is, has meant ill-considered pro-cyclical spending programs – as shown in the graphic above.  Greece was and is a large recipient of EU transfers, yet those transfers collapsed by 1.3% of Gross Domestic Product (GDP) after it was forced to cut back on its contributions to EU-subsidized projects in an effort to slash government spending.  This additional fiscal squeeze hurt growth; Greek GDP fell an annual average of 3.5% in 2009 and 2010.

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On September 21st the Fed announced that it would be selling $400 billion in short-term Treasurys and buying $400 billion in longer-term Treasurys to replace them – a maneuver titled “Operation Twist.” Atlanta Fed president Dennis Lockhart explained what it would mean for the economy: “It means lower interest rates – a lower cost of borrowing – across a whole spectrum of loan maturities.” Is he right? Well, China, Russia, and Brazil have conducted their own version of Operation Twist over the past several years, replacing roughly $330 billion in short-term Treasurys with long-term ones. The 10-year Treasury rate went sideways over that period, as shown in the figure above. Whereas the BRIC* Twist may have put some modest downward pressure on longer-term rates, other factors overwhelmed it. Don’t expect much from the Fed’s similar-sized version.

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The rapidly approaching August 2^nd deadline, as proclaimed by the U.S. Treasury, for raising Congress’s self-imposed debt ceiling is producing a flurry of deficit-reduction plans – or, more accurately, plans for having plans.  Whereas a U.S. default triggered by a failure to raise the debt ceiling is the worst possible way to address the country’s unsustainable deficits, as it would cause borrowing rates to soar and pummel growth prospects, raising the debt ceiling without a credible deficit-cutting agreement still poses real risks of imminent, damaging market turmoil.  This is because of the regrettable but real power of the credit ratings agencies, whose downgrade pronouncements trigger automatic selling and purchase-restriction directives hardwired into public and private investment fund guidelines.  S&P has announced that it needs to see a $4 trillion deficit reduction commitment over 10 years—consistent with stabilizing U.S. debt as a percentage of GDP—in order to sustain the United States’ AAA rating.  Speaker Boehner’s plan aims at only $3 trillion in cuts; Senator Reid’s plan at $2.7 trillion.  Rep. Ryan’s plan is, from a practical perspective, meaningless, as its big spending cuts don’t materialize until well after 10 years.  President Obama’s budget also falls well short of the mark, relying on wildly optimistic near-term growth forecasts to juice the GDP denominator (see the Geo-Graphic here).  As the spending graph above-left shows, both Ryan and Obama set the country off on a path of much higher spending than the average over the past 50 years.  In short, debt ceilings and ratings agencies may be stupid inventions, but they will drive us into a major economic crisis if Congress doesn’t take serious action now.

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