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Weekly Economic Commentary


Economic Fundamentals Are More Important, Debt-Ceiling Deal is an Induced Necessity

August 1, 2011

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On July 31, President Obama, Senator Reid, and House Speaker Boehner shook hands on a deal that will be voted on later today. The deal negotiated would lead to a total reduction of the budget deficit by $2.1 trillion during the 2012-2021 period. It also includes raising the debt ceiling between $2.1 trillion and $2.4 trillion by the final months of 2012. The timing and magnitude of the spending cuts as indicated in Table 3 of the latest scoring from the Congressional Budget Office (CBO's assessment of new legislation)point to discretionary spending cuts in the entire 2012-2021 period. Lower federal government outlays in 2012 in a fragile economic environment are a setback to economic growth.

Real GDP grew at a less than 1.0% in the first-half of this year, consumer spending, exports, and equipment and software spending show a significant deceleration in the first six months of the year. Government spending -- federal and state and local government – has turned negative. In this weak environment, additional projected cutbacks in spending are a negative to real GDP growth. The latest ISM manufacturing survey results for July (see discussion below) suggests a weakening factory sector. The poor fiscal status of the United States needs to be addressed with a deft hand such as not to jeopardize the fragile economic recovery in place.

dgc 0801 1ISM Manufacturing Survey Points to Weakening Factory Sector

The composite index of the ISM manufacturing survey of the United States fell 4.4 points to 50.9 in July. Readings above 50.0 denote an expansion of activity and those below 50.0 signify a contraction. The July reading is the lowest in two years when the economy was pulling out of the recession.

dgc 0801 2The index tracking new orders declined to 49.2 in July from 51.6 in June, which is the most worrisome aspect of the report. The employment index also fell as did the index measuring production, but these indices are holding above the critical mark of 50.0 which denotes an expansion. The anemic GDP report of the second quarter on July 29 and the July ISM factory survey results this morning paint a picture of significantly weak economic conditions in the United States. Overseas, the Purchasing Managers Indexes (PMI) of China (50.7 vs. 50. In June), the Euro-area (50.4 vs. 52.0 in June), United Kingdom (49.1 from 51.4 from June), and India (53.6 from 55.3 in June) declined and suggest that the global factory sector stalled in July.

dgc 0801 3dgc 0801 3b

Construction Spending Lifted by Private Non-Residential Expenditures

Construction outlays moved up in June (+0.2%) after gains of 0.7% and 0.3%, respectively in April and May. The June increase was dominated by a 1.8% jump in non-residential construction improvement that was widespread – hotels, office, health care, commercial, educational, and factory. Residential and public sector construction spending posted declines in June.dgc 0801 3c


What’s not for the WSJ to Like about the Debt-Ceiling Legislation?

Paul Kasriel

Milton Friedman taught us that the real economic cost of government is not how it raises its funds – taxes or borrowing -- but how many funds in toto it raises. That is, according to Friedman, the real economic cost of government is how much it spends. The pending legislation on the increase in the U.S. public debt ceiling dictates that federal outlays be reduced in the coming 10 fiscal years. So, the editorial board of the WSJ should be ecstatic about the outcome of this debate about the debt-ceiling increase, right? Federal spending will be decreased. But I suspect that very shortly the op-ed page of the WSJ will be complaining about this pending debt-ceiling legislation. What will be the nature of these complaints? That the legislation did not cut federal outlays enough? Of course. But more than that, the editorial board of the WSJ will be livid over the fact that marginal tax rates on personal income will be rising, beginning January 1, 2013. Unless Congress passes legislation and President Obama signs legislation to the contrary, the Bush 43 marginal personal income tax rates will revert to those that prevailed at the end of the Clinton administration. So, if the economy does not pick up between now and November 2012, mark my words, the op-ed page of the WSJ will be full of commentaries blaming the coming January 2013 tax rate hikes for this sorry state of economic affairs. I still am waiting for the editorial board of the WSJ to explain why the increase in marginal tax rates in 1993 were not associated with ensuing inferior economic performance and the decrease in marginal income tax rates, including those on capital gains and dividend income, starting in 2001 were not associated with ensuing superior economic performance. But let me guess. When the marginal tax rates went up in 1993, it was expected that surely the next president who took office in 2001 would reduce these tax rates. Similarly, because the lower tax rates that commenced in 2001 were due to expire at the end of 2010, it was expected that the rate structure would revert to that of 1993. You can explain anything by introducing unmeasureable “expectations” and “uncertainty.”

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.