U.S. Economy Boom or Doom, The Truth about the Debt Ceiling Debate
Economics / US Debt May 11, 2011 - 02:06 AM GMTBy: Q1_Publishing
Let the fear-mongering begin.
The debt ceiling debate has been positioned as a lose/lose situation.
Some claim a failure to increase the debt ceiling will lead to near-term financial Armageddon. They say the U.S. government can’t cut spending now. Deep cuts would kill the economic recovery.
Others predict increasing the debt ceiling will show the U.S. is not serious about its debt and will lead to financial Armageddon. They say additional spending cuts are necessary and not-as-big government, less regulation, and more entrepreneurialism will lead to a true recovery.
The debate will surely make for some interesting political theater. But from an investment perspective, all we have to do is look at recent history to see how this debate will play out and whether an economic boom or doom will follow.
Same Story, Same Ending
There’s no way to know exactly how the debate is going to play out. But it’s a safe bet that it’s going to play out similarly to the continuing resolution a few months ago.
There will be plenty of theatrics, false drama, and a compromise pitched by both sides as a “win.”
There will be spending cuts. They’ll sound big at first. Further investigation will reveal they’re not as large as they sound.
There will likely be tax increases. They will surely be given a new name. The words “tax” and “increase” won’t be included.
Then, over time, the inevitable will happen. Tax increases will not increase tax collections as much as expected. And spending cuts will not reduce spending as much as expected.
We’ve seen this story many times before. This time is no different.
But history we have reached a new point in the debate where both sides are willing to cut. They’re just debating about how much and where really.
And a quick look at history will give us a good guide on the economic impact.
Let History Be Your Guide
Frankly, there haven’t been too many years when the government cut spending in the past 90 years. We had to go back a long way to see real spending cuts. Given the state of the U.S. government’s deficit and debt load, it’s no surprise either.
So here’s the deal. Spending has only been reduced from year to year in 14 of the past 90 years. If we exclude the years immediately following World War I and II, the number of years spending was reduced falls to an even less impressive six.
Although the sample is small, we can see a trend that would surprise a lot of leading prominent economists today.
On average, spending reductions were followed by progressively stronger economic growth.
For example, GDP grew an average of 3.06% in years spending was cut.
The first year after spending cut, GDP growth climbed to an average of 4.53%.
Then two years after the initial spending cuts, GDP growth continued to rise to an average of 5.32%.
The trend is a clear one. Historically speaking, spending cuts were immediately followed by progressively higher rates of real GDP growth.
Is This Time Really Different?
Of course, there are a lot of variables naysayers will quickly point out.
More than half of the years in which spending was cut were following major wars. There was inevitably some pent up demand that would spike growth.
Austerity measures in Greece and the United Kingdom have eliminated growth in both of those countries. Of course, they’re both much more socialist and government makes up a huge part of their GDPs.
Also, the U.S. government hasn’t significantly cut annual spending since the 1950s. Back then the U.S. was on the verge of entering the demographic sweet spot for economic growth.
Finally, the business cycle is not closely tied to government spending either. The most recent stimulus efforts have shown no definitive correlation between massive spending increases and GDP growth.
But despite the fear-mongering and one-sided fact selection we’re about to be inundated with, we won’t have to listen to any of it.
We here at the Prosperity Dispatch (sign up here, it’s 100% free) believe that when reality and history are on your side, you’re going to make much better investment decisions.
Good investing,
Andrew Mickey
Chief Investment Strategist, Q1 Publishing
Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.
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