Is the U.S. economy in a recession?

Last year and the year before, when the market was highly volatile in the summer, everyone was panicking saying double-dip recession has arrived in the U.S. The media and popular market pundits created this hula-hoop about the recession.  The current employment rate of 8.2% does not indicate a recession. However, economists are worried about the anemic job market that is not adding enough jobs, to keep the economy going. The signs of recovery are there, although at a slow pace. At least the economy is adding jobs every month. But the fact of the matter is, the recovery in the U.S. is going to remain slow, if our politicians don’t address the underlying problems, which are: the high employment rate, uncertain market conditions, and a weak economy.

For a recession, there has to be a contraction in all the major sectors, which is popularly measured by the reports on the manufacturing index, durable goods orders, consumer confidence index, credit index, export/ imports, oil prices, GDP, inflation and the most significantly, the unemployment rate. These measurable reports and indexes were slowly introduced after the Great Depression of 1928, to measure the strength of the U.S. economy. Prior to the Depression, there was no way of knowing how the economy was functioning.  Generally, economists look at these reports to determine the health of an economy. For instance, if the unemployment rate drops to 8.3% and then the manufacturing index drops to 52, then economist and politicians would be concerned that the economy might be slipping back to recession. Of course, the economic indexes are analyzed in relation to historical benchmarks.

At this point, the U.S. are only in a slow recovery mode, everything is growing but at a snail pace. Nonetheless, this logic currently doesn’t apply to Europe. UK, France, Spain, Greece are officially in a double-dip recession. The reason: austerity measures, raising taxes on the middle class, cutting retirement benefits, long work hours, pay cuts, and very high unemployment rate. So the end result is low hiring and spending by the private sector. In the U.S., however, politicians don’t mention the word “austerity,” when, in fact, cutting back on government spending is a form of austerity. Cutting Medicare, firing people from government jobs, and cutting down on infrastructure projects doesn’t spur natural growth in a country. The leadership in the U.S. and Europe is failing to see this. Unless politicians come up with new ways to develop “organic” growth, countries will be stuck in this quagmire for a while.

S & P Downgrade

Over the weekend of August 5, 2011, Standard & Poors downgraded the U.S.’s credit rating from AAA to AA+. The downgrade from S & P is a historic moment for the U.S., one that has never happened before. I was really prepared for the worst before the market opened on Monday.  Indeed, the markets all over the world slid, with the Dow Jones index falling by 635 points. The market rout prompted a friend to ask two questions:  Why is this happening now, and can something be done? I wish I could answer these questions in a few lines. These are complex questions, so let’s address them one by one.

First, why is this happening now?

Time wise, the roots for this crisis were sowed in 2010, when Greece and Ireland almost defaulted on its debt payments. Since then, the Eurozone has managed to buy itself some time from the wrath of angry investors. A year later, Greece was again rescued, but this time the debt crisis had spread like a virus to other European countries.

Investors around the world are worried about the global growth. The growth in the U.S. has stalled, and as the biggest economy in the world, the U.S. is still trying to find its footing after the 2008 financial crisis. Unemployment is hovering above 9%, and the consumer confidence index is at its lowest.  The GDP is in shambles, as well. Around the world, in Europe, with the exception of Germany, the prospects aren’t bright, either. With Greece, Ireland, Spain, Portugal, and Italy on a possible default list, the investors are jittery about the growth and the stability of the financial system. For a sound economy, the financial system should be strong. Well, that is not the case in the U.S. and Europe, and investors are rightly rattled by political deadlocks that are becoming a blockade to growth and future prospects. China has slowed down, and India is busy fighting inflation and corruption. But more than anything else, the slide is about a trust in governments. If the 2008 financial crisis can be blamed on Wall Street traders, then the 2010-2011 sovereign debt crises can be solely blamed on politicians everywhere. Their inability to act swiftly and efficiently has shaken the confidence of people around the world.

In the U.S., the rift in the political parties was evident during the debt-ceiling talks. Republicans want to freeze spending, which is great, but with no “new” revenues, the U.S. Treasury will find it hard to reduce the current deficit. I mean, for how long you can cut spending?  Have you ever seen politicians talk about growth, economy, and job creation? I don’t think so. With all the cuts in the next decade, the unemployment rate is not going to go down anytime soon; it will increase to 10% as more workers are laid off from government jobs. In fact, I believe we have entered an era of a lost decade that started in 2008, similar to what Japan faced in the ‘90s. S & P downgraded the U.S. because they see political uncertainty for the next few years.

S & P’s downgrade is a clear message to the U.S. government to get their act together. If the U.S. is serious about getting its AAA rating back, then they will have to make amends to the budget cuts, as proposed after the debt-ceiling talks. Depending on how quickly politicians act, the U.S. can get the coveted AAA rating back by the end of the year. Today’s sell-off is a response to the downgrade. Here is another fact about the downgrade: S & P sent out its report to the Treasury Dept. at 3 p.m. on Friday. The U.S. Treasury found an error in S&P’s calculations of several trillion dollars. S&P admitted to this error, but they still went ahead and released the report at 8:30 p.m. on Friday. What gives? Ideally, they should have sat on the report for a while before thinking of downgrading. One can't help think the political motivation behind the timing of this downgrade. 

Can something be done?

Sure. Over the weekend in the G-7 meeting, the U.S., Italy, Germany, and France pledged to buy bonds of the countries on the default list. Moreover, Fed has also indicated initiating another round of Quantitative Easing, QE3, in which they will buy bonds and keep interest rates at the current level. Buying bonds by the Fed is like a stock-purchase program by corporations. It is done to boost confidence in the system and in government itself. But more than the buying spree, which is surely going to boost confidence in the markets, there has to be an effort from politicians and governments to come up with a plan to create jobs, inject confidence into the private sector, and find ways for additional revenues. In addition, a well-balanced budget will be the right place to start.

The real challenge is to identify the growth inhibitors and find natural and sustainable ways to spur growth. It’s an achievable goal, but only if politicians drop all their shenanigans and beliefs and focus on thinking on how to solve the nation’s current crisis. If not addressed soon, the current crisis will soon escalate to a crisis of the decade, with many bumps along the way.

Debt Ceiling

The word "debt-ceiling" now a days is getting a lot of attention from the media and politicians. After the Murdoch phone scandal, the debt-ceiling is on the front cover of every newspaper. Not because nothing can be done, but simply because our politicians have failed to find a common ground to agree on. 

First, we need to understand what is the debt-ceiling. It’s the limit set by the Congress on how much we can spend. If the debt-ceiling is not raised, the U.S. will basically default on 2^nd August, because they cannot borrow more as the limit is already reached. Republicans say that the government will continue to pay interest on the debt, pay for the Medicare, pay for the Armed forces, while the Democrats say we can’t pay our bills. Hell, even the Republicans say we can pay our bills, which in fact is true.

So, why a big issue about this? The House of the Representative (a total of 435) is ruled by the Republicans. Essentially, the Republicans are using the debt-ceiling as a hostage for future spending cuts. Fine with me, but that doesn’t mean we can’t raise the debt-ceiling. There has been 10-15 bills that have been floated around in the last three weeks, talking about how the spending cuts we will done over the next 10-year period. Democrats rejected them because it is not a balanced approach in creating a budget for the next decade. How much can you cut without generating additional revenues? So, finally Mr. Boehner, the Speaker of the House, got his own bill shot down by the Republicans. Basically, there is a rift in the Republican Party, and some of them feel threatened by the Tea Party—a party of White conservatives.

How does it affect a common man? Well, it does, but not directly. For that, let us first consider the scenario of the U.S. default on 2^nd August. First, the U.S. will lose its AAA rating and the US debt rating will be downgraded to an AA rating, which essentially means the cost of borrowing will go up; interest rates will go up; banks will have to increase the rates etc. Bondholders will demand interest on their money, which will lead to sell off in Treasuries and other government bonds. Big investment companies and banks buy government bonds and Treasuries, and it will be lead to increased redemption of the assets. That’s why, the market has been jittery in the last week or so, because banks and brokers are getting ready for cash redemptions from their clients. This will trigger a massive sell-off in all the major markets in the world. Second, the default essentially means that the unemployment will continue to suffer, as companies will get more conservative in their approach. Third, the infusion of foreign investment will go down (in the form of Sovereign Funds) that will slow down the growth considerably. Finally, this affects the global economy, because of the associated ripple effect, and dependence of foreign markets on the U.S.

Is this is an apocalypse? Absolutely not. Not even close. But it is going to put economy back in recession because 535 idiots (435 representatives + 100 senate members) cannot think about the nation. Countries have defaulted before and they have come out stronger. Also, during Reagan’s tenure, the debt-ceiling was raised 17 times; 7 times during the Bush era. So, you might ask what is the big fuss? Republicans don’t want Obama to win the second term and they are using anything for their political gains.