A cursory look at the US economic growth data shows that they continue to defy expectations of a slowdown and recession due to continued increases in deficit-increasing government spending.
In fact, the U.S. Treasury recently announced the December budget deficit, which shows that the U.S. collected $429 billion through various taxes, while total federal budget spending reached $559 billion.
As noted, the false picture remains how the economy avoided recession despite the Fed’s aggressive rate hike campaign. Many indicators, from the economic growth index to the US Treasury yield curve, point to a strong possibility of an economic recession, but that certainly hasn’t happened yet.
- One explanation for this was the increase in federal spending from the end of 2022 that came from the anti-inflation and protection for domestic production laws that offered unreasonable incentives for the development of manufacturing activities such as those for semiconductors on US soil .
- The second reason is that GDP has moved so far away from the $5 trillion level in previous fiscal policy cycles that the lag effect is more delayed than previous historical examples would teach us.
However, while federal spending is increasing, tax receipts are decreasing. This is why the federal budget deficit is growing at an explosive rate.
Given the length of time and the fact that the collection rate has declined further, it suggests that there is more of a decline. Clearances of tax returns are a warning of a further reduction in tax revenues.
Public revenue and growth
The change in federal receipts is substantial as government revenue comes from taxes on both corporate and personal income. Not surprisingly, if revenues and incomes decline, this will reflect real economic activity.
As can be seen, there is a very high correlation between the annual change in federal revenue and economic growth. Historically, when the annual change in federal revenue falls below 2% of annual growth, this has preceded economic recessions. The annual rate of change in federal revenue is currently negative at -5%.
We see the exact correlation by smoothing the data and using inflation-adjusted tax revenues with a 24-month rate of change. Again, a recession follows when tax collections fall below 2% annual growth rates.
This indicator “works” better as it explains the “lag effect” in the economy – that is, that the path to the contraction of economic activity has not yet been completed. The two-year annual change in receipts has fallen well below the warning threshold of 2% and currently stands at -5.77%.
While tax revenues suggest that the slack in all economic activity is more pervasive than current headlines suggest, deficit spending flows prevent economic growth from tipping into recession.
The frog and public spending
If we look at the current picture, there is no collapse of the dollar, private equity, runaway inflation or recession. However, like boiling water, the frog doesn’t realize it’s in trouble until it’s too late. Serious government efforts on deficit spending began with Ronald Reagan in 1980.
Since then, policymakers have concluded that much would be better off if deficit-feeding spending were increased. For politicians, there are only positive benefits from increasing public spending.
Most spending provides a short-term boost to economic activity, which gets them re-elected to office. However, the water temperature is clearly increasing in the long term. While the dollar has not collapsed under the weight of the fiscal derailment, the tendency to be in negative territory against other currencies is slowly increasing in temperature.
The implications for investments
Of course, as the dollar weakened and deficits grew, inflation for both producers and consumers soared. While deficits may not seem to crowd out private investment, the rise of corporate giants like Apple, Google and others crowd out innovation and new company formations.
Such activities require capital and there is a reasonable correlation between recession, deficit flows and capital acquisition (ie primary accumulation). Not surprisingly, as the dollar weakens, capital flows slow and inflation rises, the rate of economic growth slows.
This should come as no surprise, as debt used for unproductive purposes diverts money from productivity to servicing interest. The only thing deficits haven’t led to is higher interest rates and massive increases in borrowing costs.
However, this cumulative decline in interest rates came from two main sources:
- Lower rates of economic growth
- Massive interventions by the Federal Government in monetary policy.
Given the sharp increases in the federal debt since 2008 to support economic growth, the economy cannot sustain higher borrowing costs for long.
While economic growth continues to defy expectations on the surface, but for increases in deficit spending, economic growth would have flirted with recessionary levels at just 0.7% in the third quarter instead of 6.21%.
For real economic output and GDP growth, consumption is the most important element. Since deficit spending doesn’t filter down to the average household, it’s no wonder why Joe Biden’s approval ratings are at a dismal level.
Should governments use deficit spending for “productive investment” during economic downturns? The answer is clearly in the affirmative.
The inevitable recession
However, once the economy returns to growth, deficits should be reversed into surpluses to prepare for the next inevitable recession. This is the entire central premise of Keynesian economic theory.
But unfortunately, politicians, in their ongoing bid for re-election, ignore the debt repayment part. While short-term deficits may not be consequential, rising levels of corporatization, wage disparities and wealth inequality provide ample evidence that something has gone very wrong.
The bad choices
Are all the problems in the US solely the result of rampant deficit spending? Of course not. The US also spent four decades making bad political and economic choices.
- Huge increases in consumer and corporate debt.
- Transition from productive to unproductive work.
- Bad immigration policy.
- The slow erosion of the rule of law. and,
- Undermining capitalism and transitioning to socialist policies – ie state control of economic activity.
If you ignore all the evidence, an argument can be made for persistent and cyclical economic deficits. However, to suggest that “deficit spending” has no consequences is completely wrong.
It may continue this way for quite some time, and probably longer than most people imagine. But just because he hasn’t realized it yet, doesn’t mean the US isn’t slowly “boiling off deficits” like the frog in the pot.
