The Government Is Biggest Drag on US Economy

Read this and weep. The "Bad Goldilocks" effect is busy wrecking the American Economy.

"Bad Goldilocks" means the recovery is neither hot enough to inspire confidence nor cold enough to drive Fed intervention. Fear of the policy quandary is keeping many investors on the sidelines.

And quantitative easing is about to embark on a third round:

Let's say the United States economy is going into a recession or maybe even worse than a recession and you are the chairman of the federal reserve and you have to do something about it. well, the first thing that you would do is that you would lower the federal fund's rate, and that's the rate that banks lend to each other overnight and they way that you lowered if the banks don't do it on their own after you say you wanna lower it is that you print money as the federal reserve, you use it to buy usually short term treasury securities and that money gets deposited in banks. so, the demand for reserves because that what these things are, the demand for reserve goes down, the supply goes up, and the federal funds rate should go down, but what happened if you keep doing this and you keep lowering the federal funds rate all they way down so that the overnight borrowing rate is approximately 0%, what do you do then if the economy still looks like it's a bit of tailspin. well, you could still print money. you can still print money, but using that money to buy short term debt won't help any because they are not gonna lower the short term overnight interbank interest rate anymore. so, you can go out and buy other things. you could buy other things, and those other things can be longer term treasuries, or it could be other types of securities. it could be-- you could buy mortgage box securities. you could buy commercial debt and this idea of printing money not just for target interest rate, but essentially to get that money into circulation and maybe to affect other parts of the market. this is called quantitative easing and in bernanke's, although that's exactly what he's doing, he's printing money to buy other things and what the fed traditionally does when it carries about the overnight borrowing rate, he calls it not necessarily quantitative easing, but credit easing and in his mind, even though mechanically, they are the same thing. in his mind, he's saying look, i'm printing this money not just for the sake of printing the money and putting it into circulation. i'm printing money so that i can buy particular assets where it seems like there might be a log jam in the credit market because with just printing money and buying government securities, maybe the interest rates on government debt goes down, but maybe because of panic or crises interest or the prices on these things don't behave properly. so, in order to fix that credit easing in the bernanke sense would be to go out and buy this type of asset.

Got it? Looks like a scam and knowing the Obama Administration, it probably is. Looks like the recession, like a Bactrian Camel, will have two humps! Government has become its own worst enemy when it comes to the economy, with public spending putting a damper on growth that otherwise continues at a steady if unspectacular pace.

Friday's gross domestic product report confirmed what a drag government can be: While consumer spending grew at a 2.9 percent clip, state and local governments cut back spending by 1.2 percent on an annualized basis and the federal government pulled back by 5.6 percent. As a result, the GDP number showed just a 2.2 percent improvement. The report disappointed economists, some of whom had the number as high as 3 percent and beyond, and cast an uncertain future on a stock market dependent on Federal Reserve stimulus for growth. "None of this is all that surprising, so where is the miss?" wondered Brown Brothers Harriman global currency strategist Marc Chandler, after noting some fairly pedestrian and in-line quarterly growth results. "Contrary to what passes as conventional wisdom, the main drag is coming from the government itself." Before anyone starts thinking that Washington suddenly has gotten religion on spending, the bulk of the federal government cuts came from defense spending, which plunged 8.1 percent. State and local governments, facing the necessity to balance their budgets against declining revenue (not to mention the specter of Meredith Whitney's muni bond default forecast) likely will continue to cut, though that's not as certain with their federal counterpart. Washington's drop in spending came after a 19.1 percent decrease in the fourth quarter of 2011. "The government spending plunge is unlikely to repeat for a third quarter (in 2012 at least) and an inventory drag in 2Q only masks moderate demand gains," Citigroup economist Steven C. Wieting said. "But the 1Q GDP data should limit remaining optimism that U.S. economic growth will accelerate significantly this year." So what does this all mean? Investors are watching the Federal Reserve closely for signs that the U.S. central bank might step in and provide more stimulus once Operation Twist ends in June. The Fed currently is buying long-dated bonds and selling shorter-dated notes in an effort to stimulate risk and drive down lending costs. At the same time, it is rolling over the $2.8 trillion already on its balance sheet in the form of Treasurys as well as mortgage and other debt. Some are hoping that Chairman Ben Bernanke and Co. will be willing to step in with a third round of balance sheet expansion — quantitative easing — to keep goosing the market through the economic trudge. But the GDP progress, halting as it is, likely will forestall if not completely derail QE3 prospects. It's all part of "Bad Goldilocks" phenomenon, in which the economy doesn't grow quickly enough to inspire confidence but moves just enough to keep the Fed at bay. Central bank critics worry that all the liquidity efforts will spur inflation, not to mention uncertainty over what happens once the Fed has to start unwinding all that debt it is holding. Also remember: Out there not so far in the future is the "fiscal cliff" of which Bernanke has warned will appear if Congress cannot agree on deficit reduction and thus face an automatic round of steep spending cuts and tax increases at the end of 2012. "Enthusiasm for equities is likely to be curbed by a turn in the US profit cycle, an absence of additional unconventional monetary stimulus from the Fed and a renewed flare-up of the crisis in the euro-zone," John Higgins, senior market economist at Capital Economics, said in a note. "The latter should weigh particularly heavily on stock markets in the region, even though valuations are now low from a historical perspective and relative to the US," he added. Indeed, there's a lot not to like about an economy that relies on government spending as its primary growth engine. Just ask anyone in Europe. Ostensibly, the U.S. economy is consumer-driven, with private spending amounting to 70 percent of GDP. But several economists doubted that the robust 2.9 percent spending increase in the first quarter could last, raising further questions about where we go from here. "We assumed that growth would be driven primarily by final demand, but, inventories contributed 0.6 (percentage points) to GDP, putting real final sales at a weak 1.6 percent annualized growth rate," said Neil Dutta, U.S. economist at Bank of America Merrill Lynch. "Moreover, the strength in consumer spending and contribution from motor vehicle output look unlikely to repeat in future quarters." Government policymakers, then, face a dicey dilemma: Continue spending and risk falling further into the fiscal abyss, or cut back and deal with a prolonged future of uninspiring GDP numbers. "The dagger (from the GDP letdown) came from a second straight steep drop in federal government spending due to plunging defense outlays," observed Pierpont economist Stephen Stanley. "Boy, wait until these budget cuts start to kick in."

As Bette Davis said in that film in the '30s about an airplane & a difficult situation: "Fasten your seat belts, it's going to be a bumpy ride."