Almost 8 years ago, when President Barack Obama was inaugurated in January 2009, he inherited an economy that was still freshly reeling from the devastating impact of the Global Financial Crisis.
Known as the ‘Great Recession’, it technically began in December 2007 and ended in June 2009; technically referring to the definition of recession as at least two consecutive quarters of negative GDP growth. The effects of the recession were more than significant; according to Department of Labor statistics, 8.7 million jobs were lost between February 2008 to February 2010 while GDP contracted by 5.1% over the same period. Further, unemployment reached peak levels of 10% in October 2009.
Despite the official ending of the recession in 2009, the US economy continued to be in a state described as a general ‘economic malaise’ for several years later, with some even describing it as a ‘zombie economy’; neither dead or alive. Nonetheless since then, consensus has been that the US economy has generally recovered, with the latest 3Q 2016 data showing that the US economy grew by 3.2% annually; its strongest since 2014, driven by high consumer confidence and exports. The current unemployment rate of 4.9% is the lowest in almost a decade.
So it looks like over the short term at least, the American economy has at least mostly recovered from the recession. But what actually lies behind this recovery? Not many people realize this, but Obama is actually a huge Keynesian economist. Here’s a quick summary on Keynesian economics 101, courtesy of Investopedia.
An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Depression. Subsequently, the term “Keynesian economics” was used to refer to the concept that optimal economic performance could be achieved – and economic slumps prevented – by influencing aggregate demand through activist stabilization and economic intervention policies by the government. Keynesian economics is considered to be a “demand-side” theory that focuses on changes in the economy over the short run.
In Keynesian economics, government spending is said to elicit a multiplier effect, whereby a single dollar of government spending will result in a greater impact to GDP. This works because government spending ends up directly in the hands of ordinary citizens who will then spend the money themselves on private consumption, increasing overall economic activity.
The downside to Keynesian economics is of course, government stimulus has to come from somewhere, and in this case we need only look at America’s national debt figures. According to the US Treasury, the US’ national debt stood $10.63 trillion as of 01/20/09 and $19.88 trillion as at 12/02/16. To put that into perspective, that is an increase of 87.1%!
Let’s put those numbers into context. On average, public debt increased at a rate of about $1.15 trillion per year. For our assumptions, let’s assume a multiplier effect of 1.5x; a figure that is in line with fiscal multiplier estimates made by the National Bureau of Economic Research.
This means that on average, the increase in public debt would have had an impact of about $1.73 trillion per year on GDP. Over the past 8 years, the US economy, as measured by nominal GDP has an average value of about $16.5 trillion, which means that 10.5% of the entire US economy is fueled by this increase in public debt. Without this debt-fueled spending, the US would be in the worst economic depression in history right now.
And despite all this debt, the US economic recovery is still looking like the weakest recovery of the post-WW2 era.
What conclusions can we draw from this? The sobering reality remains that while in the short-term the US economy has managed to pull itself out of the recession, it has achieved this short-term economic gain at the expense of the long-term or as they say, borrowing from the future for the present. So while the health of the American economy looks much rosier compared to 2009, the fact is that when President-Elect Donald Trump is inaugurated on Jan 20 2017, he will be inheriting an economy that is still deeply troubled. The dilemma he faces is this: if he wants the economy to remain stable in the short-term, he will have to keep taking on public debt just like Obama or risk another depression. On the other hand, growing public debt will only add to our problems in the future because America as a nation has been consuming far more than it produces, something only possible due to massive public debt.
It remains to be seen how this dilemma will be handled, or if it even can be handled.
With so much of the economy resting on continued increasing public debt, it may be wise for investors to look into assets that can serve as a hedge against the entire economy.
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