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Animal Spirits Ignore Impact of Spending Cuts

Irwin M. Stelzer

Poor kids to go without lunches and vaccinations, meat sold without inspection, firemen and cops laid off, illegal aliens released from prison, 17,200 teachers fired, airports closed, 700,000 workers let go. Egypt in ferment? Syria at war? Austerity-ridden Greece? Nope. The United States of America, as described by President Barack Obama now that what is called the sequester, an across-the-board cut in some domestic and military spending, is in effect.

All this pain, says Obama, is being inflicted by those nasty Republicans, who refuse to go along with still another tax increase on “the rich.” The sequester will take $1 out of every $100 the government plans to spend in the remaining seven months of the fiscal year. On a full-year basis the reductions will come to $2 out of every $100 of spending. Not much, but better than no cuts at all given that we are borrowing almost $40 out of every $100 we spend, and that even with these cuts, government spending will be more than 7% higher than it was when the Obamas moved into the White House.

The pity of it is that the spending cuts could be apportioned more sensibly to mitigate their effect if only an epidemic of bipartisanship would break out in Washington; that it supports those, here in America and abroad, who believe the US has become ungovernable; and, most important, that it diverts attention from what is going on in the real economy.

Americans are largely inured to all the Washington Sturm und Drang and cries of “wolf.” Another budget crisis will follow this one later this month when Congress and the president have to agree how to fund the government going forward, then another when the debt ceiling issue is revisited, and still another if the politicians ever confront the real problem—that the country can’t afford all the “entitlements” it is committed to dole out.

Best to shrug and ignore the Jeremiahs who see bankruptcy or inflation in our future and get on with life, which increasingly confident investors and consumers seem to be doing. Share prices are up about 8% this past year. Consumer confidence has recovered from a January dip and is now above last year’s level. Consumers are cheerier both about the present situation and the outlook. With their balance sheets in good shape, they are willing to take on more debt, some of it in the form of mortgages.

Which is one reason the housing market goes from strength to strength. House prices in December were 6%-7% higher than a year earlier. Sales of new homes jumped almost 16% in January, and were 29% higher than last January—the highest in almost five years. Sales of existing homes also rose but by less than new homes because of a shortage of inventory, which is at its lowest level since 2000, forcing househunters out of the used and into the more expensive new house market. In response to this, homebuilders are scurrying to get new houses put up, at a pace 20% higher than last year’s build rate. Unless mortgage rates rise from current low levels (unlikely given Federal Reserve Board policy), homebuilding will contribute to growth this year rather than act as a drag as it has in recent years.

Consumers also continue to replace their ageing vehicles. Sales are running more than 4% above last year, itself a very good year. New models are proving attractive, and discounting is down. Auto makers are expecting to get a further fillip in coming months from construction workers who need small trucks to get themselves and their tools to work on the sites where all those new homes are being built. The result is the reactivation of shuttered car factories and significant new hiring. An estimated 90,000 jobs have been added since the 2009 low point in the industry’s fortunes. But one cheer only: employment is still about half of its 1999 peak of 1.2m, and many of the new workers are being hired at wage rates below those of existing staff.

Most analysts agree that the manufacturing sector is on the upswing. Factory activity in January expanded at the fastest pace in nine months. Orders for so-called core durable goods (excluding volatile orders for non-defence aircraft) jumped 6.3% in January. Both production and new orders rose in February. Société Générale’s economists, after studying activity reports, see “positive momentum in the data.”

All in all, there are signs the economy continues to grow, and it is only policymakers who stand between it and a really good year. One example of the cost of uncertainty: an oil pipeline company is reluctant to lay pipe from the new western oilfields as it can’t be certain the administration will allow continued development of those resources. Uncertainty trumps the incentive provided by the new oil discoveries.

Then there are the plans the administration has for the business community. 

  • Obamacare will cut in next year, imposing costs on small businesses that grow to need 50 employees during the current year, and on large businesses that now are contemplating paying the $2,000 tax that will be imposed on them if they do not buy mandated, generous health insurance for their employees—policies that will carry premiums in excess of $2,000 per employee.
  • If the president and the Democrats have their way, taxes on high earners will be raised yet again.
  • Regulations are being prepared that will drive up energy costs and lead to the closure of many coal-fired power plants.
  • Small groups of employees in large companies are being recognised as legitimate bargaining unions, and will be in a position to shut down a giant company even though most of its employees have refused to join a union. 
  • The president is pushing for an increase in the hourly minimum wage to $9 from $7.25.

These are called headwinds. They blow with mighty force, inducing corporate boards to seek shelter behind walls of uninvested cash. Reduce them from gale force, and the economy could sail forward more rapidly than most expect. 

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