Politics & Policies of Economic Management (Part 2)

According to the Bureau of Labor Statistics, increased consumer orders, stock price increases and increased money supply are reflective of increased consumer optimism. Current positive developments of these entities in the economy do suggest a conformation to this assertion and recovery on track. However, more months of data may be needed to validate the sustainability of the gains for these leading indicators as outlined in part 1 of this article. Now let’s talk about the politics and policies encompassing the national debt.

Regarding the national debt, it is a big issue and a bone of contention as one can envisage that Uncle Sam is really in debt. The only remedy could be a cap on spending and increase in taxes. Meanwhile, should the citizens be concerned or worried over the mounting debt? The answer is a yes and a no. Yes, because the debt cannot be kept forever without repayment. The government cannot continue in the long-term to refinance its debt as raising taxes and reducing spending will definitely become a viable option. Also, mounting debt will put a downward pressure on the dollar ceteris paribus and that could retard or derail the recovery.

The U.S GDP is projected to grow from $11,652 billions in 2008 to $14,751 billion in 2018 a ten-year period. This is gives a growth rate of 2.659% annually for the period. However, there is a precarious problem here when this growth rate is compared with the national debt and the gross debt growth rates for the country. The national debt (debt held by the public excluding intra-governmental obligations such as Social Security Trust Fund) is expected to grow from 54.6% of GDP in 2009 to 68.5% of GDP in 2014 or better still from 64% of GDP now(2010) to 77% of GDP in 2020 suggesting a growth rate of 2.03% annually. Similarly, the gross debt (debt held by public plus intra-governmental obligations and foreign investors) is also expect to grow from 86.1% of GDP in 2009 to 99.8% of GDP in 2014 a growth rate of about 2.67% annually. The growth rate for the national debt of 2.03% and gross debt of 2.67% annually should be of concern because these figures are almost equal to the expected growth rate of 2.66% for GDP in the next ten years. A comfortable figure should be a GDP growth rate that is excess or a multiple of the growth rates for the debt (national and gross). In fact, what the government must do is to institute policies that put “breaks” on the growth of the debt subsequently permitting its redemption in the nearer future. Next with regards to the answer of No to the question whether citizens should be worried, it must be said that the government can continue to refinance its debts in the shorter term but in the longer term this may not be feasible. Another non-viable option will be to print money to pay its debtors which of course will escalate inflation from its current figure of about 2.30%.

External debt such as debt to Chinese investors in the form of bond payments should be an issue of concern as it can lead to the transfer of economic power. The question is whether foreign investors (Chinese investors and others) are willing to accept refinancing as against making payments at maturity. Even if it is acceptable, for how long will it be? In fact, mounting debt and deficit could affect the country’s credit rating and create future financing problems. A cue can be taken from the Greece and Spain situation. It’s said that United States owes much of its debt to its citizens and that it can continue to defer payment for sometime. However, this should not be a creditable one as debt accumulation without remedial action can incapacitate a country as it has done to Greece. Greece may not be the last country to be incapacitated as there are several countries on the way to join the train. In fact, Greece debacle would continue to have a ripple effect first to Europe and then to the United States. Also, United States is not exempted from incapacitation that can result from the cumulative effect of rising debt. The country currently has a buffering capacity that has helped sustain it and lessened the negative impact of the rising debt. The economic buffers include the country’s high global competitiveness rating and efficient macro-stability policies that has kept inflation in check and promoted economic growth. However, the question that needs to be asked is the sustainability of these economic buffers in the long term.

Again, with regards to the growing deficit, borrowing to finance the deficit only adds to the accumulated national debt and so there is the need for strict adherence to the national debt “ceiling” (that is the limit on the national debt). Raising the “ceiling” may not be a viable option but rather cutting down on spending and increasing taxes is. It may be a painful action plan but the pay-off is great. Judiciously, remediation of the debt will also call for leveraging of the increasing balance of trade deficit between China and the U.S. As at now, the low value of the Chinese currency is causing some problems for U.S exports invariably affecting net export negatively, exacerbating the balance of trade deficit and dampening economic growth.

Currently, in the pipeline are series of regulations meant to promote leverage, transparency and probity in the financial sector with Wall Street being projected as the beacon of success if these regulations should work. This is a laudable step and should not be politicized if it seeks to leverage risks in derivatives and stock trading. As at now, options seem to be the only derivative with more leverage and consequently the one of choice for risk averse or low risk traders. Consequently, regulations that are pioneered towards leveraging risk in derivatives and financial sector by increasing transparency and promoting ethical transactions in this sector is commendable and should be welcomed. However, to some extent these regulations should seek to have minimal impact on financial innovation in the sector.

Unfortunately, due to the perception of some skeptics politicizing government regulations, it has culminated in an increased sensitivity of several companies business model to impending government regulations than to inflationary pressures. That is the business model of some financial companies has become more sensitive to impending regulation than to inflation. Cases in point are credit card companies’ responses to government’s propensity to regulate. There is the belief that government regulation will restrict their ability to make huge profits. So in reaction to that they keep increasing rates resulting in increased credit card cost for consumers. Though expectant inflation increase (called inflation psychosis) may be a contributing factor to rates increases from these companies yet government regulation is fast becoming the determinant for the rate increases. The bottom line is reduced regulation increases aggregate supply (through increased business investment) whilst increased regulation reduces aggregate supply. This presupposes any government regulation in the financial sector should be very “smart” regulations that promote sound attractive business environment consequently increasing aggregate supply.

Conclusion

The statistical figures and analysis presented in part 1 and 2 of this article does present an economy technically out of recession. However, it also suggest the need for intervention and remedial measures (including regulations) to contain the situation in the longer term as inaction will seriously “crowd” the recovery and create hardships in the future. Emphasis was placed on three factors that are critical for the economy whose remediation may require government intervention and policies. They included the growing unemployment rate, rising national debt and the indeterminate consumer confidence. It was iterated that the successful recovery of the economy in the medium-long term will be determined by these three factors. Also the outlook of the economy and the ability of the country to maintain its superior power economically and military-wise will also depend on these factors. The growing debt requires policies (mostly fiscal) that put brakes on the debt growth. There is also the need to protect investors (both foreign and local) through very “smart” regulations that produce the required leverage of risks, ensures transparency and ethical transactions or remunerations in the financial sector.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/