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A Rocky Road ahead after Election

2012 may be a year of decision for voters, but 2013 will be a year of crisis for lawmakers. Looking at the immediate future, Washington confronts several challenges converging on it simultaneously. The most obvious challenge is the “fiscal cliff,” an event triggered by Washington’s rapidly exploding debt burden. In the last hours of campaigning, how to discharge the national debt is a question without an answer.

For the moment, positive economic news has muted these concerns. Cautious optimism has been the theme this month on Wall Street, a feeling buttressed by tentative signs of economic recovery. Specifically, the latest employment report showed 171,000 new jobs, exceeding the 125,000 expected. This news bolstered consumer confidence ratings and the growing faith that the US housing market is beginning to recover, temporarily allaying investor fears.

However, momentary exuberance in the marketplace is not new. In fact, it is part of an overall trend reaching back several years. Investors ride economic roller coasters, euphoric one day and depressed the next. Truly, market rallies come pretty cheaply these days, courtesy of FED QEs or a dip in the “official” unemployment number. But volatility in the stock market, uncertainty among investors and business leaders, and economic slowdowns overseas in Europe and now in China suggest a fragile global economy.

Fragility is the real story. For every modicum of positive economic news, there is a pervasive sense inside the financial sector that America’s alleged economic recovery could easily succumb to any number of major weaknesses in Europe, Asia and at home. In tune with these fears, there is an unspoken truth: America desperately needs across the board reform to sustain a real economic recovery—a new tax code, regulatory modification, a restructuring of entitlements, and deficit reduction, among other things. And there is little confidence that any new Administration beleaguered by partisan paralysis can produce these changes.

The fiscal cliff will be the opening round in a long, potentially devastating struggle for economic recovery. Recent projections by the Congressional Research Service (CRS) predict a mild to severe recession in the first quarter of 2013 if we go over the fiscal cliff. A trillion dollars in spending cuts (sequestration) plus the expiration of the Bush tax cuts, the Payroll tax cuts, the expiration of unemployment insurance, and raising the national debt ceiling (set at 16.4 Trillion) await lawmakers as soon as the election is over. These issues, though severe, only tell part of the story.

The main crisis is the state of the US economy. While official unemployment statistics show a steady drop in unemployment (listed around 7.9%) and a growing economy (however modest), over twenty million people in America are unemployed or underemployed and almost fifty million are living on food stamps. In addition, the collapse in the US housing market during 2008 dramatically lowered household income, eroding the wealth of millions of American families.

The magnitude of these problems is only fully realized when government enters the picture. Today, the US federal government represents 24.6% of GDP, almost one fourth of all economic activity. A century ago in 1912 government represented a mere 2% of GDP. Other comparisons are equally staggering. For example, today Congress controls 33% of the US budget—67% is automatic spending due to legally binding entitlement obligations. One hundred years ago Congress controlled 97% of spending. Simply put, the federal government has grown so big that cutting it significantly is both difficult and extremely painful.

So why not spend our way out? Obama’s solution ignores the national debt in favor of massive government spending and borrowing. But America’s days of borrowing are numbered. Unlike the previous fifty years of deficit spending, US economic growth is flat lining. The pivotal relationship between growth and borrowing is fracturing, fatiguing the bond market until a breaking point. If America cannot return to high growth levels quickly, the US bond market will start to give, interest rates will rise, and the streets of major US cities will resemble those of Greece and Spain.

This impossible scenario is no longer impossible. Weaning America off such incredible dependency in a time of anemic economic growth will be painful irrespective of who wins the election, especially when returning to growth requires offloading America’s disastrous debts. The question is how painful?

Cameron Macgregor is a USNA grad and former naval officer. He is currently a graduate student at George Mason University.

 

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