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The US Congressional Budget Office
(CBO) said on August 22, 2012, that scheduled tax increases and spending cuts
in 2013 would reverse the current modest economic recovery. The CBO and other
experts are of the view that large government spending cuts and tax hikes
will cause severe economic slump.
Experts hold that without action by
Congress to avoid a "fiscal cliff" Americans should expect a
significant recession and the loss of some 2 million jobs. The CBO predicts
that the real GDP could shrink by 0.5 percent next year while the
unemployment rate could climb to around 9 percent.
The "fiscal cliff" refers
to the impact of around $500 billion in expiring tax cuts and automatic
government-spending reductions set for 2013 as a result of successive
failures by Congress to agree on some orderly alternative method of reducing
budget deficits.
According to the CBO projection the
budget deficit could fall to $641 billion in 2013 from $1.128 trillion in
2012.
We suggest that the goal of fixing
the budget deficit as such could be an erroneous policy. Ultimately what
matters for the economy is not the size of the budget deficit but the size of
government outlays — the amount of resources that government diverts to
its own activities. Note that, because the government is not a
wealth-generating entity, the more it spends, the
more resources it has to take from wealth generators. This means that the
effective level of tax here is the size of the government and nothing else.
For instance, the government
outlays are $3 trillion, and the government revenue is $2 trillion —
the government has a deficit of $1 trillion. Because government outlays have
to be funded, the government would have to secure some other sources of
funding, such as borrowing or printing money, or new forms of taxes. The
government is going to employ all sorts of means to obtain resources from
wealth generators to support its activities. What matters here is not the
deficit of $1 trillion but that government outlays are $3 trillion. If
government revenue from higher taxes were $3 trillion, then we would have a
balanced budget. But would this alter the fact that the government takes $3
trillion of resources from wealth generators?
According to the CBO data,
government outlays are expected to fall in 2013 by $9 billion to $3.563
trillion after a projected decline of $40 billion in 2012.
Given that there is a time lag
between government outlays and their effect on economic activity, it strikes
us that it is the cut of $40 billion this year rather than the cut of $9
billion next year that should be of concern to various worried commentators.
 
We hold that an increase in
government outlays sets in motion an increase in the diversion of real
savings from wealth-generating activities to non-wealth-generating
activities. It leads to economic impoverishment.
So in this context is it really bad
news for the economy if on January 1, 2013, we have an automatic cut in
government outlays? Most commentators such as the IMF and the CBO are of the
view that cutting government outlays could inflict severe damage to the real
economy.
We suggest that a cut in government
outlays should be seen as great news for wealth generators. It is of course
bad news for various artificial forms of life that emerged on the back of
increases in government outlays.
What about the fact that we will
also have an increase in taxes as a result of the expiration of the Bush tax
cuts? To the extent that government outlays are going to be curtailed the
increase in taxes should be regarded as a monetary withdrawal from the
economy. In this sense it is like a tight monetary policy. A tighter monetary
stance in this respect should be seen as positive for wealth generators since
it weakens various bubble activities that sprang up on the back of past loose
monetary policies.
(Conversely, a reduction in taxes
while government spending goes up is not a tax reduction as such but should
be viewed as loosening in the monetary stance. Again, an increase in
government amounts to an increase in effective tax. The government has to divert
resources from wealth generators to support the increase in spending.)
Note that the CBO projection of the
future state of the US economy is in terms of GDP. Given that GDP is in fact
monetary turnover, its ultimate course is going to be dictated by the rate of
growth of the money supply. The more money that is pumped, the stronger GDP
is going to be.
Contrary to the CBO and most
commentators, we suggest that what is likely to undermine the growth momentum
of GDP next year is the current visible decline in the growth momentum of
money supply. In the week ending August 13 our monetary measure, AMS, fell by
$70.9 billion from July. The yearly rate of growth of AMS fell to 6.5 percent
from 12.3 percent in July. Observe that in October last year the yearly rate
of growth stood at 14.7 percent.
As a result the yearly rate of
growth of real AMS (AMS adjusted for CPI inflation) fell to 5.1 percent in
mid-August from 10.9 percent in July. Based on the lagged-by-14-months yearly
rate of growth of real AMS, we can suggest that the growth momentum of
industrial production is likely to weaken sharply from the second half of
next year.
The growth momentum of industrial
production and real GDP could be in trouble from the second half of next
year, but the underlying economy should start strengthening. The demise of
bubble activities will be good news for wealth generators.
Against the background of a
still-weak labor market, we suspect that Fed officials are likely to
introduce another massive pumping in a few months' time. Given the current
time-lag structure, it is unlikely however that more pumping can avoid a
decline in the pace of economic activity in terms of GDP from the second half
of next year.
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Summary and
Conclusions
According to the US Congressional
Budget Office, scheduled tax increases and spending cuts in 2013 (the so
called "fiscal cliff") could reverse the current economic recovery.
We suggest that a cut in government outlays is actually going to be good news
to wealth generators. It is, however, going to be bad news for various
nonproductive activities that emerged on the back of increases in government
outlays. In the meantime, a serious threat to economic activity in terms of
GDP is posed by a visible fall in the growth momentum of money supply. We
suggest that the present fall in the growth momentum of money supply is
likely to undermine the GDP rate of growth from the second half of next year.
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