Well they finally did it – raised the debt ceiling. Now everything is cool again and we can all go back to enjoying life and watching the economic recovery unfold. Well, maybe not.
While everyone was focused on the political circus in Washington and our self-inflicted shot in the foot, it seems that the stock market went back to focusing on things that matter - like a slowing U.S. and global economy and sovereign debt issues that just won’t go away.
When it was announced that a “deal” on debt reduction and the debt ceiling had been reached, the stock market exploded about 150 points to the upside. Unfortunately, the euphoria lasted about an hour before people realized that the underlying economy continued to deteriorate, and the stock market has been mostly in free-fall since.
While the world was fixated on the debt ceiling debate, first and second quarter GDP figures were released on July 29th and they were not pretty. First quarter GDP had previously been reported at a disappointing 1.9 percent when most economists were looking for something over 3 percent.
Remarkably, the market just yawned and nobody seemed to care. Economists started to revise second quarter GDP estimates down to 2.7 percent.
Second quarter GDP actually came in at a shocking 1.3 percent. At this stage of an economic recovery we should be growing at close to 4 percent. But even worse than that, the first quarter GDP figure was revised down from 1.9 percent to a snail pace .4 percent. On top of that, fourth quarter 2011 GDP figures were revised down from 3.1 percent to only 2.35 percent.
This is shocking and quite worrisome. All the money in stimulus and quantitative easing that has been thrown at the economy and that’s it? Almost two years after the recession “officially” ended, the economy has still not recovered back to pre-recession levels.
But at least things are good now because Congress has reached an agreement on how to reduce our deficit, right? Not likely. As I understand it, the compromise calls for $2.4 trillion in spending cuts over the next ten years. We need at least $4 trillion over 10 years to come anywhere near to keeping the debt level from increasing.
Many of the cuts being discussed are not cuts from current amounts being spent, but cuts in projected spending increases.
While there is no question that we need to reduce spending, nobody wants to talk about the effect doing so will have on the economy for at least the next decade.
As my friend and hedge fund manager John Thomas points out, a $2.4 trillion reduction in government spending over 10 years is 16.6 percent of GDP, or an average of 1.6 percent a year. Unless that is somehow offset by an equivalent amount of growth in the private sector, which is not likely, we will guarantee minimal economic growth for at least that period and worse if anything goes wrong.
The Federal Reserve has a current forecast of 3 percent GDP growth. That is highly unlikely. But even if that somehow happens, taking 1.6 percent away from the economy means a paltry 1.4 percent GDP growth rate. A rate that low will do absolutely nothing to reduce overall unemployment.
Keep in mind that an agreement to raise the U.S. debt ceiling and reduce government spending, or kicking the European debt crisis further down the road will not have any effect on the current global economic slowdown. It only provides temporary relief.
What does all this mean for the stock market? While the economy and the stock market are certainly related, they don’t always move together. We may well be experiencing a long overdue correction that may run its course soon, leaving us with a possibility of a year end rally. We’ll see.
Nick Massey is a financial columnist for The Edmond (Okla) Sun. Contact him at nickmassey.com.