Only in today’s America would a shrinking economy cause the stock market to rise.
The federal government reported this week that the U.S. economy contracted by -0.1% in the last quarter of 2012. That helped the stock market finish its best January performance since 1994, with the Dow Jones Industrial Average up 7% since November (it was the best performance since 1989 for the S&P 500).
As the chart shows, S&P 500 performance since November has been eerily similar to last year’s performance at this time.
So why did a shrinking economy produce a rising stock market? Because it all but guarantees more quantitative easing (QE), as well as resistance to federal spending cuts, which would reduce gross domestic product (GDP).
QE is the stock market on steroids. It pumps up performance short-term, but it’s a performance that’s not grounded in reality. It drives investors to take on more risk in search of higher returns. And long-term, like steroids, it is unhealthy.
The timing of the shrinking economy is fortuitous for Keynesians, as sequestration is scheduled to take place next month unless a budget deal can be negotiated. Unless Congress can reach a budget deal, sequestration will create $984 billon in automatic spending cuts through 2021. With the reduction in debt service, the reduction would come to $1.2 trillion.
That amounts to a cut of about $55 billion in defense spending and $55 billion in non-defense spending, or a total of just $110 billion a year from a budget that’s grown to about $3.8 trillion.
That’s just under 3%. Yet those who oppose the cuts point out that the reductions in Gross Domestic Product (GDP) that would result will send the economy back into a recession.
Where’s the Growth?
If quantitative easing and federal spending cause economic growth, why has growth been so stunted over the past few years, when we’ve had record amounts of both?
From 1948 to 2012, the GDP of the United States grew at an annual average rate of 3.22%. Since coming out of the recession, growth has been underwhelming, resulting in an unemployment rate that’s hovered around 8% for years. GDP grew at a rate below 2.4% in 2010, just above 1.8% in 2011 and 2.2% in 2012.
As we previously pointed out, the greater the recession, historically the greater the rate of growth coming out of the recession has been. For the four recessions in the ’60s, ’70s and ’80s, the cumulative growth fell between 15% and 20%. Yet the cumulative growth rate for the three years following the last recession is just 7.13%, according to The Wall Street Journal.
That should indicate that the combination of QE and high federal spending is not helping the economy.
Both QE and a high rate of federal spending will have undesirable consequences, including adding to the federal debt and eventually increasing inflation. Current levels of federal spending are unsustainable and will lead to an increasing amount of funding needed just to service the debt.
So why do we continue to pursue these policies?
Consumer Confidence
An economy shrinking by -0.1% doesn’t sound too alarming. But another way to look at it is that the economy is not growing.
The federal government had previously estimated growth of 1.5% in the fourth quarter. Instead, we had a no-growth fourth quarter for several reasons:
- Businesses were reducing inventory, instead of purchasing
- Government spending was down at all levels
- Exports were lower, particularly to Europe
Inventory reductions could mean good news ahead, as businesses will need to buy more as inventory runs low. Combined with the improving housing market, some see an improving economy ahead.
But there’s still plenty to be gloomy about. Americans are still adjusting to contributing an extra 2% of their income to payroll taxes and to other tax increases.
The tax increases resulted in a drop in the Conference Board’s consumer confidence index, which fell 8.1 points to 58.6, its lowest level since November 2011.
Increased government spending would result in higher taxes in the future and another hit to consumer confidence. So is increased government spending really the best way to create economic growth?