Investment Contrarians

Why the GDP Reading Should Be Ignored

By for Investment Contrarians |

Reading Should Be IgnoredIf you believe the recent gross domestic product (GDP) reading, you would think the country is doing well, on its way to better times ahead—but hold on.

The third estimate of U.S. GDP growth showed a stellar 3.1% annualized rate, according to the Department of Commerce, well above the 2.7% estimate. But before you get too excited, know that the reading was aided by government spending, which increased 3.9% in the third quarter and contributed 75 basis points to the GDP reading. (Source: “Exports, government spending buoy third-quarter growth,” Reuters, December 20, 2012.)

While the government-aided GDP is positive, my concern is that the fiscal spending will likely begin to slow, given the pending “fiscal cliff” on January 1. And yes, it will happen; albeit, I’m not sure what the actual impact will be as the two parties continue to debate the mechanics.

One thing is for sure: America doesn’t have a lot of capital to freely spend. But then it has always been able to go to the printing presses to issue more money into the system and add to the out-of-control national debt.

Just take a look at the Federal Reserve. The printing of money in America will continue and intensify after the announcement of a more aggressive stimulus strategy that will involve the additional monthly buying of $45.0 billion in longer-term Treasuries on top of the existing $40.0 billion monthly buying of mortgage-backed bonds from the third round of quantitative easing (QE3) in September. (Source: Federal Reserve press release, December 12, 2012.) My concern is that the additional buying of bonds will add another trillion dollars to the Federal Reserve’s balance sheet in 2013, driving the amount up to $4.0 trillion, and this is not good.

Essentially, America has printed money and pumped up its national debt to keep itself afloat. The country is fast approaching the $16.4 trillion in national debt that is legally allowed under the current debt ceiling. With the current national debt at $16.24 trillion, time is running out, which is why the resolution of the fiscal cliff is needed. President Obama wants a hike in the national debt ceiling in order to allow the government more flexibility in its spending. Failure to raise the national debt limit would mean the government accessing emergency funds to avoid a default and the need to initiate the fiscal cliff cuts and tax increases in some form.

So far, the talks between House Speaker John Boehner and President Obama have resolved little.

Moody’s Investors Service warned it may cut the U.S. triple-A debt rating for a second time in 2013 should the government fail to deal with the financial crisis and reduce the national debt-to-GDP ratio. A rating cut would translate into higher yields required for the U.S. Treasury to compensate for the higher risk.

The Congressional Budget Office (CBO) predicts the U.S. economy could contract by 0.5% in 2013 if fiscal spending is curtailed. (Source: Congressional Budget Office, last accessed December 20, 2012.)

We have a “catch-22” situation on our hands with fiscal spending and the national debt.

The problem is that a cut in fiscal spending and higher taxes at this stage, given the fragile economic recovery, are major risks for the country, and they could drive America into another recession. On the other hand, if cuts aren’t made and taxes are not increased, the country’s national debt will continue to spiral out of control, and it will be given to another generation to deal with. Did I mention we have over $16.0 trillion in national debt?

In my view, it may be time for some short-term pain to achieve long-term gains!

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