When the Federal government begins its withdrawal from the economy, the implications will be large and the ramifications likely painful.
We saw it when Cisco’s stock plunged 16% after reporting earnings partially compressed by a reduction in government contracts.
We see it every day as temporary Federal stimulus wanes and takes more and more steam out of the economy (whatever steam was really there in the first place).
We see it in surreal discussions where small business owners complain about government spending at the same time asking the government to free up or firm up government contracts to their industries.
We saw it quite dramatically last week as investors in municipal bonds bumrushed for the exits partially because of uncertainty over whether the Build America Bond program will continue. The Federal government set up this program to help states and local municipalities remain solvent by providing access to cheaper financing, financing not otherwise possible given their collectively horrendous financial condition. It is a huge irony that some investors have flocked to these investments as tax shelters from fear of higher future taxes when these very investments are probably only attractive because of the artificial supports provided by the federal government.
*Chart created using TeleChart:
One of the many confounding ironies about our current condition is that many years of massive government spending across both Democratic and Republican control of the purse strings has created entrenched, vested interests in government largess in all corners of the economy. If we ever doubted this fact, we got to see it play out in the various reactions to the proposals of President Obama’s National Commission on Fiscal Responsibility and Reform. Its report created few friends and generated plenty of criticism (which probably means the report is on target).
As the pressure mounts to reduce the scope and size of government, we should brace ourselves. Sometimes it seems a residing assumption exists amongst too many that this process can be executed in some pain-free manner or that only “undeserving” constituencies (choose your favorite scapegoat or scratching post) will lose out on benefits. In the long-term, a fiscally responsible government is a great thing for our country. However getting there will certainly cause pain generously distributed across the land and will require various sacrifices. If the process is conducted fairly, almost everyone will be giving up on programs, services, tax credits, tax shelters, subsidies, etc… that we have come to take for granted. If there is any humaneness to the process, the body politic will step up to fill in the void where government can no longer afford to help those in dire need. If the process is executed rationally, we will figure out creative and innovative ways to maintain the investments in our country that we need to keep the economy structurally sound for future generations. Yes, I am trying to be optimistic here!
In his book “Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange”, Marc Chandler notes that before the year 2000, government consumed 1/3 of the nation’s entire economic production (when I reviewed Chandler’s book earlier this year I focused on other chapters). I have to assume that portion has grown since then. In other words, there is little chance that we will get to long-term fiscal stability without experiencing short-term retrenchment and upheaval in our economy.
(Side note: the New York Times produced an interactive feature last week to allow people to make their own choices in balancing the budget and sharing their proposals online. See “Budget Puzzle: You Fix the Budget“. I cannot wait to give it a shot!)
Be careful out there!
Full disclosure: long CSCO