Why I’ve Learned To Love The Sequester

The Sequester, at first glance, seems to take a lot of money out of the economy, but the 80-85 billion the Sequester will take each year if allowed to stand is  equal to what the Federal Reserve Bank (FED) adds back each month. One way to look at it is to think of the Sequester as reducing the economic stimulus produced by the FED by one-twelfth. It helps that the Sequester will start slow and pick up speed by the end of the year at which time the FED had, indeed, previously planned to start to downsize and eliminate its stimulus of the nation’s economy. Of course, these are two entirely different kinds of programs. The FED buys 80-85 billion in U.S. treasuries per month while while the Sequester will reduce government expenditures across-the-board by only 80-85 billion per year. The FED program is inflationary and promotes economic growth while the Sequester is deflationary and potentially inhibits growth.

The FED program has been underway for a few years now and is scheduled to begin to end soon. The concept was that even in the absence of government action the FED program would create an inflationary counterbalance to a potentially runaway deflation created by the 2008 financial crash. In the virtual absence of Congressional action on either fiscal or monetary policy by the 112th Congress, the FED was the only game in town. While fighting deflation with an inflationary fiscal policy is one of the few approaches to take, it is rarely done as it is such a frightening strategy for a central banker to take.  Indeed, Ben Bernanke may turn out to be a great hero or miserable goat as a result of instituting the program known as Quantitative Easing (QE). If we can begin to downsize the program and effectively exit by 2014 or when unemployment in America has fallen below seven percent, we may be all right in the end. The worry is that retention of this program in the face of the continued, accelerating growth of the economy will produce and over-heating effect and we may face massive, runaway inflation at the other end. This time of reckoning could come soon, say about 2014-2016.

Indeed, the economy has been picking up in the last year and shows signs of accelerating this year already. The Dow has now reached an all time high and exceeds the previous high made in 2007. We can expect even smaller investors, both foreign and domestic, to come back into American markets , both equities and stocks. Money around the world is beginning to increasingly look at American equities and bonds as safe havens for investment. Even though QE has stimulated stocks and depressed interest being paid on U.S. bonds, they are increasingly regarded as safe investments. Greek, Italian and Spanish or other Eurozone bonds pay substantially more interest, but can one count on collecting 4-6 percent or more in profits from these notes. If they default on their debt or debt is reorganized, you may collect far less profit, if you collect anything at all as these bonds come to maturity. As U.S. markets improve, foreign investments are on the increase to substantial a level — coupled with increased domestic investment. We may find the Sequester to be a first step countervailing force to help quell the accelerating stimulus of the FED’s QE program. In fact, the Sequester may help the FED plan a more rational and slower disengagement of QE beneficial for a soft landing in 2014-2016.

It is highly likely that the FED will begin to plan out an effective QE disengagement between now and the end of the year. The FED is beginning to watch and plan more closely as jobs reports and other positive economic data are reported. A measured reduction in QE by about 5-10 billion per month before this summer even would be a reasonable plan. This could cut QE by half before the end of the year. Afterwards the FED could begin a measured reduction of the remainder of QE to be concluded by the end of 2014 at the latest.

While this happens, the government has the opportunity to revise both tax revenues upward while cutting  unwarranted subsidies and tax loopholes as well as address  the longer term solvency of both Social Security and Medicare/Medicaid. The government should gradually try to cut debt accumulation substantially. There are limits to how far this can be accomplished by direct action even if a balanced program of increasing revenue and reducing expenditures is reached.

A slow but steady effort to close the government yearly deficit gap added to the actions of the FED over the next year and a half could result in sufficient business confidence to kindle the kind of reinvestment in jobs necessary to stimulate the economic growth necessary to close the further close the revenue-expenditure gap in the federal budget. Business has substantially repaid the debts of 2008-9 and are now in many cases running up high levels of profits and growing surpluses, sizable portions of which could be reinvested in new jobs without diminishing company value to investors.

In the end, we may look back at the Sequester as a counter-intuitive, invaluable, but key first step, in the gradual and necessary disengagement of the FED and re-engagement of government resources as well as the re-dedication of substantial capital now accumulating private industry.

The Sequester may have signaled the first important step in a national reawakening of priorities and a basis for redirecting the economy.

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