Last Friday, the Commerce Department reported a 2 percent annual increase in Gross Domestic Product (GDP) for the third quarter, marking an improvement from the previous quarter’s growth of 1.3 percent. However, it’s important to temper any excitement about this development.
Lucia Mutikani from Reuters points out that the economy really needs to sustain growth above 2.5 percent for several quarters to effectively lower the unemployment rate. Moreover, the recent growth figures do not stem from genuine wealth creation, such as that derived from savings and investments. Instead, they reflect an artificial growth that occurs when capital is depleted and assets are consumed. Let’s delve deeper into this issue.
Consumer spending, which constitutes roughly 70 percent of the U.S. economy, surged by 2 percent during the third quarter. In contrast, incomes rose by only 0.8 percent. This 1.2 percent gap is unlikely to have been compensated by savings.
It’s notable that 40 percent of Americans have $500 or less in savings, and 28 percent have no savings at all. This reality indicates that the discrepancy between the rise in consumer spending and the increase in incomes was largely financed through new debt, effectively borrowing against future earnings.
The government also contributed to GDP growth, accounting for a 0.7 percent increase in the third quarter. However, given that the government ran a $1.1 trillion deficit in fiscal 2012, this contribution was similarly based on future borrowing. Thus, the third quarter’s GDP figures primarily reflect the extent to which consumers and the government are accumulating debt, rather than actual economic expansion.
No Easy Solution
After years of escalating debt, the economy has become reliant on it. Consequently, new public and private debt is essential for stoking GDP growth; without it, the economy contracts, leading to cascading defaults akin to an avalanche in the Rocky Mountains.
At this juncture, merely slowing the creation of new debt could unravel the entire economic framework. Through relentless debt accumulation, the government has entangled the economy, leaving no straightforward exit without significant fallout.
Government approaches that increase taxes while simultaneously cutting spending are rarely implemented. Yet, in moments of Congressional dysfunction, this combination may become the only viable option.
All attention is currently directed towards the presidential election on November 6. Following this, regardless of the outcome, focus will shift to the looming fiscal cliff. If a last-minute agreement isn’t reached, we could witness a severe economic downturn as the government drives the economy off the fiscal cliff.
Former Treasury Secretary Larry Summers recently warned that if action isn’t taken regarding the fiscal cliff, “you’re looking at an overwhelming likelihood of serious recession and you’re looking at a real threat to national security.” Nevertheless, finding a simple solution is challenging. While increasing taxes might exacerbate the situation, reducing public spending is necessary, even if it temporarily hampers economic growth.
Just last week, leading CEOs shared their thoughts on tackling the fiscal cliff…
How to Fix America’s Debt
In a letter to Congress, the CEOs of over 80 major U.S. corporations emphasized the urgent need for a plan to address America’s debt. They suggested the following measures:
- “Reform Medicare and Medicaid, enhance the overall efficiency of the healthcare system, and limit future cost growth;”
- “Strengthen Social Security to ensure it remains solvent for future beneficiaries;”
- “Implement comprehensive, pro-growth tax reform that broadens the base, lowers rates, raises revenues, and reduces the deficit.”
It is unsurprising that the CEOs spotlight entitlements, Social Security, and taxes as critical elements in their call for a credible plan for debt reduction. These programs have long been recognized as unsustainable, and the burdensome tax system has been stifling the economy. Nonetheless, previous calls for Congressional action have largely fallen on deaf ears.
Sadly, most Congress members are unlikely to give much consideration to the CEOs’ letter. Furthermore, very few will support the necessary reforms outlined. Why is this?
Engaging in meaningful reform requires diligence, thoughtful discussion, and difficult choices—qualities that Congress has often fallen short of. Additionally, endorsing the CEOs’ proposals may jeopardize their electoral prospects, prompting them to pursue the contrary path instead.
Politicians might prefer to avoid facing the facts and opt to increase spending. For a Congressman, it’s more appealing to promise prosperity than to balance the government’s budget to align with economic realities. Ultimately, this procrastination will lead to a much harsher reckoning as creditors pull back their support, resulting in a genuine crisis. In the meantime, Congress’s inaction will only exacerbate the situation.
Sincerely,
MN Gordon
for Economic Prism
