Friday, April 15, 2011

Why .02% 2011 Budget Cut Is Good News For Investors

The budget deal that kept the government from shutting down on April 9 reduced spending by next to nothing in U.S. budget terms. And that’s great news for investors in U.S. stocks. How so? A quick look across the pond is all it takes to answer that one. The UK is in aggressive budget balancing mode and all the cutting of its government spending is sending its economy in reverse.

And a shrinking economy is an awfully hard place for companies to beat earnings expectations. If the U.S. had passed meaningful budget cuts, they would have the same economic braking effect as they did in the UK. And thanks to bitter rifts within the Republican party as 2012 approaches, the Democratic leadership should have little trouble exploiting those divisions to keep the Republicans from derailing the economic recovery.

The budget deal that passed Thursday afternoon only reduced 2011's deficit by 0.02%. That's because the Congressional Budget Office (CBO) calculated that the budget reduction that was touted as being $38.5 billion of the $1.5 trillion 2011 deficit only amounts to $352 million in reduced cash outlays in 2011. To their credit, the 25% of Republicans who voted against the bill were doing so on the principle that this deal did nothing to reduce their cherished goal of cutting government spending -- couched as deficit reduction.

To understand the gap between the $38.5 billion advertised budget cut and the actual $352 million one, it helps to point out the distinction between budget authority -- an amount that many government departments could be authorized to spend over a multi-year time frame -- and check cutting. When a department gets ready to cut a check, Congress often does not authorize the spending -- and the CBO arrived at the $352 million by estimating how much the budget bill reduced the amount Congress had actually authorized that government departments would withdraw this year from the Treasury's General Fund (the government's checking account).

A look at what's happening in the UK suggests that budget cuts are bad for the economy. According to the New York Times, its deficit reduction plan is sending the UK's economy into the worst shape it's seen since the 1930s. How so? The UK's deficit is now 10% of its Gross Domestic Product (GDP) and its "top economic official," George Osborne, wants to reduce that deficit to 1.5% of GDP by 2015 through budget cuts, 75% of which will come from social programs. The result is that the UK is slashing its GDP growth forecasts from 2.4% to 1.7% as family income falls 2% and British retail sales tumbled 3.5% in March.

Why is the UK inflicting this pain on itself? It apparently believes that its interest rates are too high -- a belief not born out by reality since the UK's 10-year treasury rates are just a bit over Germany's 3.6% -- and that those high interest rates are holding back investment. Fortunately, the US does not suffer from high interest rates -- at 3.51% our 10 year rates are at near-record-low levels.

Thus there is no economic point at all to what Paul Ryan (R-Wisc.) calls deficit reduction -- actually a $4.5 trillion tax cut for the wealthiest Americans coupled with a $5.8 trillion cut to spending on Medicare and Medicaid, according to the Times. And fortunately for those who like having adults in charge, there is no political point -- beyond losing in 2012's Presidential election -- for Ryan's proposal.

That's because after forking over $23.8 trillion in government cash and guarantees to bail out Wall Street in 2008, there are plenty of Americans who are in no mood to give those same fat cats another $4.5 trillion in tax cuts while taking a big hit on their health care expenses that are already rising every year -- between 20% and 60% in 2011 according to the New York Times -- far faster rate than general inflation's 1.6%.

After enjoying a record year of $1.68 trillion in corporate profits and expectations of 17% 2011 earnings per share growth, investors ought to draw comfort from the realization that even unlimited corporate spending on political campaigns cannot overwhelm the common sense of  Americans -- many of whom will realize when they enter the voting booth in November 2012 that a plan that robs from the bottom 99% of Americans to further prop up the top 1% is not in their best interests. 


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