Cut The Stimulus Package To Decrease The Deficit

American GDP growth was much better than expected in the second quarter of the year, falling only 1%. Unemployment statistics were surprisingly good as the jobless rate actually improved from 9.5% in June to 9.4% in July. These pieces of good news and other data marking the recession’s end have caused a number of experts to forecast that the economy will actually grow modestly during the current quarter. Goldman Sachs expects GDP to grow at 3% in the second half, up from its previous estimate of 1%. UBS predicts third quarter growth will be 2.5% and fourth quarter GDP expansion will be 3%. It would be dangerous to extrapolate these figures into 2010, but if the jobs market grows and there is any reasonable rebound in consumer spending during the year-end holiday season, it would not be unreasonable to believe that GDP improvement in the first half of 2010 will move up to 4%.

The Congressional Budget Office issued a March report in which it predicted GDP would grow 4.1% in both 2010 and 2011. The CBO report admits that the accuracy of its forecast becomes less certain when projected over a two or three year period. This means that the chances that GDP will outperform its expectations are roughly as good as the odds that it will under perform. The CBO report said that the Obama budget estimates were too aggressive. The White House projects that GDP growth will move up sharply to 5.2% in the 2011 fiscal and 6.2% the year after.

The June FOMC GDP projections for 2010 were between 2.1% and 3.3%, but one member had a higher forecast of 4%. The body’s projection for 2011 was 3.8% to 4.8%, but the member with the highest forecast predicted GDP would rise 5%. The Fed’s numbers for what it calls “error” range are fairly high at plus or minus 1% for 2011 and plus or minus 1.5% for 2011. The Fed is saying, in essence, that its figures are an educated guess.

All of the revisions of the last month, particularly the ones of the most recent week, are a strong signal that the Administration’s numbers, which just a few months ago were considered magical thinking, have some chance of coming true.  The size of the deficits may end up being smaller than many economists have expected and the relationship of the deficit to GDP may not be as bad as most forecasts indicated just a month ago. This may seem like a leap of faith, but it may also simply be a swing of the pendulum from late 2008 when some well-regarded economists believed that there was a reasonable chance that America would go through another Great Depression. A March CNN poll showed that the fear of the economy falling apart completely went well beyond pessimist experts. Forty-five percent of those questioned believed that another depression was likely within a year. Those numbers would almost certainly be sharply different if the poll was done today.

There are some signs that the economy has become self stimulating.  The federal government recently came out with numbers that showed it has underestimated saving rates for several years. A fair amount of data show that the pace at which Americans save has actually increased in the last year. One way to analyze this is that people are concerned about their jobs and high credit card balances. They are hoarding cash in case their personal circumstances get worse.

The other side of the argument is that consumers are waiting for the prices of many goods and services to drop to levels which are so relatively inexpensive that they have not been seen by anyone born after the 1960s. Their money in reserve is being kept until they believe that the bargains created by the economic calamity are irresistible. The popularity of the “cash for clunkers” program is a very clear sign that consumers have access to capital well beyond most estimates.

The other unexpected trend of the last month is the recovery of the industrial sector, an event that was almost completely unexpected. MarketWatch recently wrote “it’s not just autos that are doing better. Aerospace, construction materials, metals, plastic and rubber should also rise, according to economists for Merrill. In July, nine of 18 industries reported higher orders in the Institute for Supply Management index.” Capital spending and a pick-up in retail activity could accelerate that trend quickly.

The recent good news about the economy may have as a by-product an unexpected improvement in the unemployment rate. Most experts expected joblessness to rise above 10% in the early part of next year and stay above 9.5% for months. A broader view of the economy reveals that it is improving enough that June employment, at 9.5%, could have been the peak and that the jobs market will stabilize for the balance of the year and begin to improve in 2010.

The IRS will be the immediate beneficiary of an increase in the fortunes of American companies. Enterprise tax receipts which have been plunging year-over-year may begin to improve. A stable employment base followed by a recovery in two or three quarters would also increase personal payments to the IRS.

Treasury Secretary Geithner recently asked Congress to increase the statutory limit of the federal debt from its current level of $12.1 trillion. He said that the deficit is growing fast enough so that the figure might be up against that ceiling as early as October. This will touch off another violent debate about whether the US can afford a federal budget with growing deficits, a huge stimulus package, and health care reform that will almost certainly be front loaded with unimaginable costs. Any program to cut the deficit would be welcome by taxpayers and probably the nervous largest buyers of US debt.

An economy that is stimulating itself, essentially healing the deep wounds inflicted in 2007, 2008, and early this year, is an economy that would allow the government to reduce the stimulus package and US borrowing. It may seem unbelievable, but the worst downturn since the depression, which deeply affected the economy almost overnight, may be receding faster than most people could have imagined. The need for spending all of the $787 billion stimulus package may be a thing of the past.

Douglas A. McIntyre