A slew of negative news pushed the major stocks indexes down for the week ending November 25, 2011. The S&P 500, NASDAQ, and DJIA all fell more than 4.5%. The negative news included continued European debt woes, a failed German bond auction, a downward revision to third quarter U.S. GDP figures, and the announcement that the congressional supercommittee was unable to agree on a solution to cut the national deficit by $1.2 trillion.
Europe’s debt issues are old news now, but what surprised many was the failed German bond auction. Demand for German bonds has been strong throughout the debt crisis; however, demand fell dramatically last week, forcing the European Central Bank to buy nearly 40% of the offering. This, along with pressure on France’s AAA credit rating, leads investors to believe the issues of Portugal, Ireland, Italy, Greece, and Spain are beginning to affect the Eurozone’s strongest nations.
In the U.S., third quarter GDP growth was revised down to 2.0% from 2.5%. Most of the revision was due to a reduction in inventories. The truly disappointing news came out of Washington when the congressional supercommittee announced that it could not agree on $1.2 trillion in cuts to the national deficit. We will now see across the board budget cuts, split evenly between defense and other programs beginning in 2013.
Washington continues to show us that party lines are more important than making progress on our fiscal issues. It is time they wake up and smell the cheese. As of June 30, 2011, government spending as a percent of GDP is 25.5%. Revenues are only 17.1% of GDP. Over the last 65 years, spending has averaged 19.6% of GDP, while revenues have averaged 18.0%. That means that over the last 65 years, we have averaged adding 1.6% of our economic output (GDP) to our national deficit. Now the gap between revenues and spending has widened to 8.4% of GDP, the widest level on record.
With revenues 5.0% below historical averages, we do have a revenue problem. But that problem can easily be fixed by a simplification of the tax code. The larger issue remains government spending. At 30.1% above historical averages, we are way beyond Keynesian spending. If we attribute the historical 1.6% deficit to a revenue deficiency, we still see that spending is 70.2% of our problem, while revenue is only 29.8% of our problem.
The math is simple and the solutions don’t need to be complicated. Unfortunately, it appears that we will have to wait until after next year’s elections to see a solution.