August 26, 2009 – According to the National Bureau of Economic Research, the United States has been in an economic contraction since December 2007. It is now the longest contraction since World War II and without any doubt, the deepest since the Great Depression.
Every economic contraction varies to some degree, so no two are alike. However, there are recurring events that repeatedly appear time and again regardless of the length and depth of the contraction. This is particularly true with regard to the financial impact of the contraction on the federal government.
For example, as economic activity declines, jobs are lost and unemployment rises. As a consequence, the outlays made under various government compensation schemes for unemployment relief invariably increase. Other government expenditures also increase as politicians attempt to stimulate economic activity.
Looking at the other side of the government’s ledger, its revenue always drops. As economic activity declines in a contraction, so too does national income, which means the government’s tax take also falls.
Higher outlays and a declining tax take if left unchecked can be a recipe for financial disaster. In this regard, the federal government is no different than every individual. Poor financial planning and poor spending decisions lead to the same outcome. The inescapable truth is that if you spend more than you earn, financial trouble is the inevitable result.
The federal government has long been pressing the limits of prudent finance. Even before the current economic contraction began, for years it has been spending more than it was taking in from taxes, with these deficits increasing the federal debt. That is bad enough, but what is really alarming is how sharply the gap between outlays and revenue has been widening during the present economic contraction. The federal government’s financial position is deteriorating rapidly as it adds to the mountain of debt for which it is already responsible.
Please take a close look at the following chart of federal revenue and outlays, which are overlaid on top of federal debt. To smooth out monthly swings and to better identify the underlying trend, outlays (red line) and receipts (blue line) are presented as a 12-month moving average. Federal debt (vertical bars) is presented in absolute amounts.
Note the yawning gap between outlays and receipts, marked by the red lines on the right side of the chart. Not only is this gap widening, there is no sign yet that the growth of this gap is beginning to lessen.
Outlays are soaring as unemployment worsens and the government concocts various schemes to spend money in an attempt to jumpstart the economy. Concurrently, the revenue collected by the federal government in various taxes is dropping like a stone along with economic activity. As a consequence, the federal debt is beginning to surge at an accelerated rate that is well above the trend established throughout the decade.
Note too that this chart is presented in log scales, to clearly demonstrate the acceleration of this debt. This log scale also makes clear the acceleration in outlays as well as the decline in revenue.
There is only one logical conclusion when looking at this chart. The federal government is headed for a financial disaster. The trends in the above chart must be reversed to avoid a financial calamity. The federal government cannot continue to spend more than its tax take at the accelerated rate it has been reaching since this economic contraction began. Continued widening of this deficit will weaken the federal government’s financial position to the point where its creditors will call into question its creditworthiness.
Some argue that government expenditures need to increase even further to lessen the effects of the economic contraction. However, their argument is based more on wishful thinking and the principles of crank Keynesian economics than hard facts.
There was an excellent article about recessions in The Wall Street Journal on August 21st. If you thought Big Government was helping make this current economic contraction less painful, then it is time to think again.
Alan Reynolds, who is a senior fellow at the Cato Institute, writes: “Recessions have become longer as the U.S. government (and the Fed) became larger, more expensive, and more involved in the economy. Foreign countries in which government spending accounts for about half of the economy have also suffered the deepest recessions lately, while economic recovery is well established in countries where government spending is a smaller share of GDP than in the U.S. In short, bigger government appears to produce only bigger and longer recessions.”
The table below, which accompanied the WSJ article, provides the clear evidence to support Mr. Reynolds’ conclusion. Spending by Big Government is no panacea.
Economic contractions end when the excesses of the preceding boom are finally worked off. The banks extended too much credit during the boom, creating the illusions of prosperity. These excesses are now being dealt with in the present bust – loans are being either repaid or defaulted.
To sum up, the federal government is flirting with a financial calamity. Its financial position is deteriorating rapidly, which has distressing implications for the dollar. Its journey to the fiat currency graveyard is becoming all but certain. Too much government spending is leading to excessive government debt. The burden of this debt will be lessened by Mr. Bernanke’s printing press, which means that the US dollar is headed toward hyperinflation.