A fiscal policy implemented during President Bush’s period in office, which included cuts in taxes and increased government spending, is set to expire at the of this year. That means higher taxes, cuts in government spending, and a reduced budget deficit.
On the bright side, the Fiscal Cliff will cut $100 billion in government spending on the U.S. military and other government programs. These cuts would see the annual U.S. budget deficit fall from seven percent of U.S. gross domestic product (GDP) to four percent of GDP. (Source: Wall Street Journal, August 22, 2012).
It’s a perfect scenario, because it enables the U.S. government to finally lower its budget deficit. Unfortunately, in this case, it is actually bad news for the economy.
Yes, the budget deficit will be reduced, but on August 22, a Congressional Budget Office (CBO) analysis showed that the Fiscal Cliff will cause a recession in the upcoming year, causing GDP to contract by 2.9% and unemployment to rise up to 9.1%.
Issue at hand: if government spending is cut and taxes go up, it will lower the budget deficit, but also march the economy right back into recession as the budget deficit decreases. (That’s what many economists are now saying. This economist says we’re headed back to recession, Fiscal Cliff or no Fiscal Cliff.)
The U.S. economy is already facing this long laundry list: recessions in Europe; a slowing economy in China; high domestic unemployment; record high national debt; and eroding corporate profit growth…all mirrored in multiple years of budget deficits.
President Obama has stated he will not sign an extension of the Bush-era tax cuts. If the Republicans win the November election, my bet is that they will extend the tax cuts and government spending initiatives to give Mitt Romney an opportunity to get his “feet wet” with the budget deficit.
No matter what the government does—implement the government cuts, raise taxes, or not—it’s stuck in one of these “damned if we do, damned if we don’t” situations.
As I have clearly documented in these pages over the past two months, the evidence shows the outlook for U.S. economic growth is bleak at best. I am still convinced that better days are not in sight for a while.
Activity at Chinese factories slowed the most in nine months and the U.S. Purchasing Manufacturing Managers index (PMI) fell to 47.8 in August—the lowest level since November 2011. The index is measured on a 100-point scale and readings below 50 are considered indicative of economic slowdown. (Source: Reuters, August 23, 2012.) And PMI has been below 50 for last 10 months!
The economic slowdown is widespread and not only contained in the eurozone, the U.S., or China alone. One country after another is feeling the effects of it.
Japan—the biggest trading partner with China—is witnessing an economic slowdown as well. The trade deficit in July for Japan fell more than expected, with exports falling 8.1% from a year earlier. (Source: Bloomberg, August 21, 2012.) Australia and Taiwan are also seeing exports decline with China.
The economic slowdown in China is a true example of the slowdown in the global economy. China’s exports grew by only one percent in July and factory output was at its lowest in three years! The country’s exports are falling while the central bank of China has been trying to stimulate the economy. It has cut interest rates twice since June, but the economy doesn’t seem to pick up.
Why does it all matter? The U.S. economy is highly affected by economic slowdown in the global economy, and growth in China’s economy is critical.
The eurozone’s ripple effects have reached China, Japan, Taiwan, and Australia. What does it mean? The crises are now spreading. The global economy is starting to show signs of an economic slowdown—and China’s economy acts as an indicator. (See: Prospect of Global Economic Recession Can No Longer Be Ignored.)
As I have been suspecting, the U.S. is already seeing an economic slowdown of its own. A few good numbers don’t mean that the economy is back to the growth stage. The root causes at home are still the same: unemployment; debt; and declining standard of living.
As a result of this economic slowdown in the global economy, the U.S. will witness further decrease in wealth, consumption and an escalation of current issues—a vicious cycle that seems to have no end.
Where the Market Stands; Where it’s Headed:
Only a couple of trading days left in the month and it looks like the stock market went nowhere in August. The Dow Jones Industrial Average is ending the month close to the same level it started the month. We are near the end of bear market rally in stocks that started in March of 2009. (Also see: Where the Stock Market Goes From Here.)
What He Said:
“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.