As for the budget itself, the $4 trillion and $5 trillion savings in the proposals of both political parties are mostly achieved at the end of the decade when many of the people involved will not be in office. Near-term cuts are modest. Unless Congress is willing to make major adjustments in Medicare, Social Security and defense spending, our annual deficits will continue to run over $1 trillion. The recent Congressional election in a normally Republican upstate New York district in which a Democrat won may be instructive. The Republican supported a major change in Medicare on the grounds of fiscal responsibility. The Democratic victory came as a result of the voters choosing the candidate who wasn’t going to take something away from them that they were clearly counting on. This is why it is so hard to reduce government expenditures. If the goal of anyone in office is to get re-elected, it is difficult for any incumbent to practice fiscal discipline. We are seeing the same problem in Europe as the troubled economies try to implement austerity programs. The political future of democracies in developed countries may be a battle between populism and conservatism with some form of financial crisis determining the outcome. It won’t be pleasant to witness.
One favorable factor is that state and local government budgets are in surplus, having offset the cutbacks in Federal funding. Quarterly state revenues are up 10% from the previous year, a sharp change from the 15% decline during the recent recession. This doesn’t mean that some of the more troubled states like New York, California, Michigan and Illinois have solved their problems, but in aggregate the overall state of municipal finance seems to be improving.
Another persistent worry is that the Chinese economy is in the midst of an economic bubble or blow-off that is sure to come to a bad end. Concern is that the housing industry there is vulnerable and the banking system might be threatened as a result. The country’s high-single-digit growth has been fueled by excessive capital spending and much of that is wasted, the critics argue. I just returned from my second trip to the region this year and I remain an optimist. The Chinese economy has many problems, but the basic strength results from growing consumerism and I believe we will continue to see impressive growth for several more years, at least.
Overall, I think the world economy continues on a modest growth path. The developed economies should expand at a real rate of 2% and the developing economies at 5% or better for an overall rate of 4% for 2011. The rise in initial unemployment claims, some weak reports from regional Federal Reserve districts, mixed housing data and the disappointing durable goods report have many observers worried that the economy is seriously slowing. Many economic observers are reducing their estimates of economic growth for the United States for the remainder of the year. This may be what is needed to convert investor sentiment from optimistic about the outlook to serious concern and that could form the platform for a better market after the summer.
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