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My worst fears are slowly, but surely coming true.  Over the course of the last 3 years I have written hundreds of articles describing the balance sheet recession and why the government was the only entity that could step in and fill the void as the consumer remained weak due to the bubble era debts.  I said the government should focus its efforts on helping the root of the problem  – Main Street and not Wall Street.  And while the stimulus did a great deal to help bolster the private sector over the last 2 .5 years, it’s now becoming a drag on the economy as it wears off and reveals a still very fragile U.S. consumer.

When the Congress passed the tax cut at the end of last year it looked like we were avoiding the austerity bug.  How quickly things change.  It’s difficult to imagine that there is much left in the spending tank.  And yes, spending is the accounting equivalent of tax cuts (except the government gets to allocate the funds more specifically via spending).  As the balance sheet recession lingers, the result is that the US economy is likely to remain pitifully weak in the coming years barring some miracle debt revival from the private sector (which would actually be a setback for the healing process of the balance sheet recession).

According to ZeroHedge and JP Morgan the recent debt package is going to result in a near stagnant economy in the coming year.  In other words, the austerity bug is starting to bite.  My “muddle through” predictions from earlier this year could be too optimistic:

“Regarding the cuts that CBO didn’t score, one of two things can happen: either the Committee successfully finds $1.5 trillion in deficit savings over ten years, or they are unsuccessful and sequestration automatically reduces spending by $1.2 trillion evenly over ten years beginning next October, with the onset of fiscal year 2013. In the former case, if we assume the cuts ramp up slowly, as is the case with the discretionary caps, then this might add about another $20 billion of fiscal tightening in the coming year. If the latter, we would also see spending decline by a similar amount, though all back-loaded in the last quarter of 2012. As such, regardless of how the Committee fares, it appears that a first rough estimate is that the total tightening implied by the recent legislation would subtract about 0.3%-point from GDP growth next year.

This drag may appear fairly small, but it is on top of the substantial tightening that was already in place prior to the passage of the debt deal. Most of that fiscal tightening comes about through the automatic expiration of temporary stimulus measures. The table below details those measures, the largest of which is the one-year 2%-point payroll tax holiday, which expires next January. Other large programs that are scheduled to expire or phase out are emergency unemployment benefits, accelerated depreciation, increased transfers to the states, and much of the remaining spending associated with the 2009 Recovery Act. All in all, by our estimates federal fiscal policy will subtract around 1-3/4%-points from GDP growth next year. Given that GDP growth has been 1.6% over the past four quarters when fiscal policy has been much less of a drag, this doesn’t bode well for next year. There are elements of uncertainty in our 1-3/4%-point drag estimate, and the largest such uncertainty is probably political, as some measure could get extended. Respecting that uncertainty, it does appear that fiscal policy poses a downside challenge to our projection for 2.7% GDP growth in 2012.”

As Warren likes to say, because we think we’re the next Greece, we’re becoming the next Japan…..

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