Tags: fiscal | drag | bubble | economy

Are We Really Experiencing Fiscal Drag?

Thursday, 16 January 2014 07:53 AM

A number of economic and financial analysts have been predicting that 2014 will be the year the economy finally turns around, or at least starts growing at a healthy pace. Of course, they have been predicting the same thing every year since 2009; but this time it's different, in part, because we can expect reduced "fiscal drag" in 2014.

The theory is that trying to get the federal budget under control has been a drag on the economy. Now that everyone in Congress has agreed NOT to get the budget under control and to just borrow a lot more money, we can finally stop worrying about this drag and get the economy moving again.

Of course, the very idea that we've had any fiscal drag in the economy is ludicrous. The government is projected to borrow $744 billion in 2014. Sure, that's a lot less than the nearly $1.5 trillion deficit in 2009. But it's still four times what the government was borrowing before the crisis, even after adjusting for inflation.

More importantly, the $680 billion we borrowed last year was about twice the amount by which GDP grew. Add to that the $900 billion the Fed is on track to print this year — more than the entire monetary base in 2007 — and it's clear that massive fiscal and monetary stimulus is the only reason the economy is growing at all. Take these factors away and we'd be in deep recession. Then we might know what fiscal drag feels like.

This is a perfect example of the kind of inverted logic we're seeing in the financial community today, as if it's normal to borrow over $1 trillion a year and any pullback on that constitutes a drag on the economy.

It's also the logic we see in the stock market, where so-called experts have delivered rosy forecasts based on what are sure to be record profits among the biggest companies. Predictions of earnings growth for the S&P 500 of 8 percent or even 10 percent have come from some very reputable firms.

What everyone seems to ignore is that last year, when the S&P 500 rose almost 30 percent, earnings were almost flat. Revenues have been flat for more than two years. In fact, since the end of 2011, the S&P 500 has risen 45 percent, while profits have risen only 11.2 percent. Some might suggest that a market so divorced from fundamentals might be due for a crash — but not Wall Street.

Now, to be fair, stocks may indeed rise in 2014, and the economy may grow more than in 2013. After all, bubbles tend to grow bigger before they pop. But, all the good time bubbles now come with a big price tag when they inevitably pop. And when those bubbles pop, it will be a lot worse than a little "fiscal drag."

About the Author: Robert Wiedemer
Robert Wiedemer is a managing director of Absolute Investment Management, an investment-advisory firm for individuals with more than $300 million under management. He is a regular contributor to the Financial Intelligence Report, the flagship investment newsletter of Newsmax Media.
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A number of economic and financial analysts have been predicting that 2014 will be the year the economy finally turns around, or at least starts growing at a healthy pace.
Thursday, 16 January 2014 07:53 AM
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