Comment 81: Recession Watch; serious cut of government budget deficit will induce a recession (July 23, 2011)

The current economic recovery from the deep recession of 2008-2009 is not a normal recovery based on the vigor of the economic system. It is an artificially engineered recovery supported by massive government deficit spending. A portion of money created by Federal Reserve Chairman Bernanke goes into the direct purchase of U. S. Treasuries to enable U. S. Government to do the massive deficit spending. Another portion of Bernanke's money becomes hot money that flows mainly into China, wanting to be exchanged for Chinese Yuan. In order to prevent the rapid appreciation of Yuan vs. U. S. Dollar, Chinese Government buys up those incoming hot dollars and release the matching amount of Yuan into the hands of speculators that have brought in those hot dollars. As described in article 16, those hot dollars transform into hot Yuan, spurring China's sizzling infrastructure construction boom, and thus fueling China's bubbling economic growth and inflation. On the other hand Chinese Government is forced to bring the dollars purchased from hot-money speculators and from China's trade surplus back into the U. S. money market to lend out. Some of those flow back dollars goes into purchasing more U. S. Treasuries to further enabling the deficit spending of U. S. Government, and some of those returning dollars are lent to speculators to inflate various bubbles from stocks to commodities. Under such an unstable system, if the deficit spending of U. S. Government is curbed, another recession is sure to follow.

In Comment 77 of August 16, 2010, it has been pointed out that the recovery of Personal Income is mainly due to the Government transfer of money into the pockets of consumers. The progressive component of Personal Income, that includes private wage and salaries, proprietor's income, and interest and dividend income, is only growing meagerly. Since one year has passed from the last data used in Comment 77, it is worthwhile to look at the situation of Personal Income again. In the graph at the right, the progressive component of Personal Income is plotted as the green dots, and Government transfer as red dots. Both curves are plotted in linear scale with units of trillion dollars. We can see that the progressive component lost 700 billion dollars during the recession, but only regained 450 billion dollars by May of 2011, whereas Government transfer component has jumped more than 400 billion dollars since the onset of the recession. The public works program thrown in by Government to stimulate the economy is contributing to the rise of the progressive component, too. Considering all this, it should be clear that the recovery is still mainly upheld by the massive government deficit spending. This also underscore our warning that serious cut in government deficit spending will induce another recession.

American economy is in a bind. Before going into any cut of government's deficit spending, the economy seems to have lost steam in spite of Bernanke's massive monetary stimulus already. It looks like that U. S. economy has fallen into the situation that we call “Japan Syndrome", too. Under the Japan Syndrome, the central bank may inject all the liquidity it wants, but the liquidity does not flow into the pockets of consumers so the economy just stagnate. Thus to keep the economy not falling into another recession, massive deficit spending by the government becomes necessary. This means that huge government budget deficit will continue as far as the eyes can see. What if the massive budget deficit is allowed to continue? Such bizarre situation, of course, cannot continue forever. Eventually the whole economy will collapse into a depression. One may ask how comes to such a bind? It is the inevitable result of three decades of wanton attempt of “borrow and spend" policy under the name of “globalization" undertaking by every administration since the Reagan administration.

The dilemma facing the U. S. economy has come into open in couple with the issue of raising the debt ceiling. House of Representatives that is controlled by conservative Republicans wants immediate spending cut in exchange for the vote of increasing the debt ceiling, whereas White House wants to avoid immediate spending cut from the fear of inducing another recession. White House is talking to cut entitlement spending including social security and medicare. Such cut in entitlement spending will only be kicked in after several years. White House wants to increase taxes to offset some deficits, to the strong opposition of conservative Republicans. We should point out that tax increase at present has similar effect of inducing a recession as immediate spending cuts. White House's attempt seems to be tax increase later to avoid direct harm to the current economy. In other words White House's attempt is to talk, but do nothing about deficit cut at present, and conservative Republicans are not buying the strategy. Also liberal Democrats are upset about ever talking to curtail the entitlement spending. On the other hand bond rating agencies are threatening to lower the rating of U. S. Treasuries if a comprehensive plan to cut government deficit in long term is not produced now. Under such turmoil and dead lock, we believe that it is prudent to issue a “recession watch" at this juncture.