Slashing government expenditures is great when the economy is growing normally. But when it's not — watch out
Government spending is often wasteful. But it's still spending.
When the Department of Waste, Fraud & Abuse buys toothpicks for the office cafeteria, that money is received by somebody. The recipient then buys other goods and services, circulating money through the economy. The money may not flow to its highest and best use, but it still flows.
What happens when the government money stops flowing?
If the economy is growing normally, then the ex-government money can be returned to the taxpayers who will spend it on something else, probably something more useful.
But what if the economy is not growing normally?
President Obama's 2012 budget, submitted in February of this year, proposed $33 billion in cuts from federal agencies as part of an overall five-year freeze in non-defense discretionary spending.
Businesses are hoarding cash. They're not spending.
Since then, the scale of proposed cuts has grown bigger and bigger and bigger. These cuts may not ever materialize. But if they did — you know, that's real money they're talking about. If the government were to spend less at a time when households and businesses still hesitate to spend more, well then ... you don't have to be an Orthodox Keynesian to recognize that less money would be spent.
And spending less money has real-world consequences for real-world suppliers and vendors.
So here's the question:
If government is to cease providing extra demand to the U.S. economy sometime after, say, August 2 of this year, who will provide that demand instead? And how?
One obvious source of demand: International customers. U.S. exports are booming, with a record $175 billion worth of goods and services being sold overseas in April. U.S. exports for 2011 should rise by 25 percent over the level of 2009.
U.S. exports are sustained by the cheaper dollar. Yet perversely, many of those who advocate reducing government's demand also and simultaneously advocate tightening money to raise the value of the dollar. A tighter dollar would, of course, curtail exports. That means new demand would have to come from... well, where?
American consumers are using every additional dollar that comes their way to pay down debt. They have reduced household debt service to below the level of 1995, and are on their rapid way to below the level of 1980. They're not spending. Businesses are hoarding cash. They're not spending. Unless the dollar remains low or even heads lower, foreigners won't be spending. And yet, it's agreed by just about everybody that government must reduce its spending.
The economists call this prospect: "Fiscal drag."
You and I might call it a formula for a slowing economy in the months ahead.
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