Why the Economy is Turning Down

A number of economic reports have come in lower than expected recently and the talking heads on TV are perplexed as to why a sudden downturn is taking place. Listening to their commentary, you will hear all sorts of fanciful explanations except the most obvious one – the massive government deficit spending that has been the reason for the apparent economic recovery has been frozen because the U.S. national debt ceiling hasn’t been raised by Congress.

The debt ceiling is currently $14.3 trillion and this was reached in May. Debt was already getting close to this figure as early as February however and federal spending was decelerating long before May. Based on the 2011 fiscal year budget (which runs from October 1, 2010 to September 30, 2011), the U.S. was on track for a deficit as high as $1.65 trillion this year. This represents approximately 11% of U.S. GDP. This 11% is just the deficit part of federal government spending, not all of it. Subtract this from GDP, you would see GDP was only around $13 trillion – lower than before the Credit Crisis began.

Moreover, the part of the GDP generated by the deficit is being paid for with borrowed or printed money. Actually, it’s mostly printed money. The amount of quantitative easing planned by the Federal Reserve in the first half of the year is enough to cover 70% of the deficit.  The government issues bonds to pay for the deficit and then the Fed buys them with printed money. This is what has been making the economic numbers look better and is being described by the mainstream media as an economic recovery.

A monkey wrench was thrown into the works however when Congress refused to raise the debt ceiling. As a consequence, deficit spending has ground to a halt for a while (expect it to return soon) and this in turn slowed down the Fed’s effort to inject newly printed money into the economy. How dependent the health of the economy is on deficit spending supported by the Fed’s phony money operation has become apparent in recent economic reports.

The May non-farm payrolls indicated only a 54,000 increase in jobs for the month. Moreover, the previous two months were revised downward by 40,000 jobs. The manufacturing sector, which has been leading the recovery, actually lost 5,000 jobs. Close examination of the figures indicates there are well over two million less people in the labor force than last year at this time. If they had remained in the labor force, the current unemployment rate would be 10.6% rather than the reported 9.1%. It would be highly unusual for the labor force to shrink at all, let alone by over two million, if the economy was growing as it supposedly has been. People leaving the labor force make the unemployment numbers look better than they are though and government statisticians are well aware of this.

Regardless of how much recovery has taken place, it is clear that the goods producing sector of the economy is weakening. While the ISM Manufacturing report for May still indicated expansion, every component was lower than it was in the April reading. New Orders and the Backlog figure were barely positive.  The highest component, as has been the case for many months, was Prices Paid – a measure of inflation. It was down from a whopping 85.5 in April to a still very high 76.5 (above 50 indicates expansion). Much of the growth in manufacturing has occurred because the items coming off the assembly line cost more, not because of there are more of them. The Durable Goods reading from April, the most recent, was down 1.2%, confirming less demand for the output of U.S. factories.

Tying it all together are the Leading Economic Indicators (LEI), an indication of where the economy is heading. These were down 0.3 in April, indicating the economy is likely to continue to lose steam. LEI will probably stay weak until the deficit ceiling is raised and newly printed money can start flowing back into the U.S. economy at its formerly prodigious rate. If this doesn’t happen, Americans might discover that just like the proverbial emperor, the U.S. economy has no clothes.

Discloure: None

Daryl Montgomery,
Organizer, New York Investing meetup
Author: “Inflation Investing – A Guide for the 2010s”, Volume 1
http://www.amazon.com/Inflation-Investing-Guide-2010s-ebook/dp/B0051GU06W/ref=sr_1_3?s=books&ie=UTF8&qid=1307366974&sr=1-3