<

Shutdown economics 101: Kudlow versus Reich

Part 2
Shutdown economics 101: Kudlow versus Reich (Part 2 of 10)

Shutdown 101: Government spending, nothing exceeds like excess

But at least I got a good rate

The below graph reflects the long-term trends in US government spending as a percent of gross domestic product, or GDP. Under the Obama Administration, this growth in spending has been in response to the post-2008 economic crisis. Republicans have dug in their heels on this level of spending, and seem to be playing a game of high stakes poker with the government, with a partial government shutdown in play, and a broader government shutdown on the horizon–slated for October 17. This article examines the components of government spending and considers the views of both political parties with regard to a major economic shock hitting the US economy this month, and considers the implications for equity investors.

US Government Spending as a p of GDPEnlarge Graph

Budget breakdown

As the above graph indicates, total spending (the blue line) has made an unprecedented jump upward in the Obama Administration. Why is this? As if the recession post-2008 weren’t bad enough, entitlements (Medicare, Medicaid—the yellow line) have played a major role. Plus, discretionary spending (mainly defense—the red line) has also ballooned as the military presence in Afghanistan continues and other Middle East hot spots create global tensions. On a positive note, despite this tremendous growth in spending and debt, net interest (the green line) as a percent of GDP has declined to roughly half of what it was in the early ’90s—thanks to the extreme measures of the Federal Reserve Bank’s quantitative easing measures taken post–2008 collapse. Yes, publicly held debt may have doubled under Obama from nearly 35% of GDP to 70%, though the average interest paid on this debt has apparently declined by half since the Clinton Era.

From forth the fatal loins of these two foes…

With the conservatives insisting on fiscal austerity, and the Democrats insisting on the Keynesian solution of more spending, both parties have accused one another of economically suicidal approaches to managing the economic crisis.

Thesis: Kudlow

Larry Kudlow comments on Creators.com, “Government Shutdown. So What?”, that he has seen these mini-shutdowns before: “Yes, the Washington Monument and a bunch of public parks closed. So what? Non-essential personnel got a holiday. The rest of us had to work.”

Antithesis: Reich

On the other hand, Robert Reich and the Democrats seem to be more concerned with the shutdown. As Robert Reich points out in “Why Obama and the Democrats Shouldn’t Negotiate With Extortionists,” using Obamacare as a hostage in the negotiation process doesn’t justify the disruption to the average government worker or potential risks to the American economy. Obamacare is the law of the land, and if the Republicans don’t like it, they can take it up in a separate bill. Visiting the Washington Monument and national parks (not to mention the online database of the Bureau of Labor Statistics!) shouldn’t be interrupted as a result.

Synthesis

Yes, the deficit is high. We all know that. However, interest rates are low. In fact, they’re seductively low. Is there an average American worker out there who wouldn’t think twice about  getting a new credit card with a $100,000 credit limit at 1% APR for the first 30 years? Yes, there are many, and Larry Kudlow seems to be telling them all to tear it up and throw it in the garbage in the name of saving the economy. Lenders are simply imprudent. The average American finds this an unconvincing argument, and Kudlow’s pro-austerity laments are seeming to be met with deaf ears in both Washington and on Main Street.

Shutdown investing: Outlook

Should Congress and the President fail to make progress on budget discussions, investors may wish to consider limiting excessive exposure to the US domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM). Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples–related shares, as reflected in the iShares Russell 1000 Value Index (IWD). Plus, even the global blue chip shares in the S&P 500 or Dow Jones could come under pressure in a rising interest rate environment accompanied by sequester-driven declines in consumption, investment, and economic growth. So investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY), Blackrock iShares S&P 500 Index (IVV), or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs. Until consumption, investment, and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution, and consider value and defensive sectors for investment.

The Realist Discussions