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18 January 2013

Clawing Our Way Out of the Defecit, Recession

Many investors fear that the U.S. has generated such a large deficit that we cannot grow out of it, but the data shows an historic reduction in the U.S. deficit ratio.

The U.S. national deficit compared to GDP is shrinking at an historic rate, according to the Office of Management and Budget (OMB). This office says that our deficit ratio is improving at the fastest rate since we demobilized at the end of WWII. Higher numbers on the graph below denote a smaller relative deficit. The last three bars show the reduction in the ratio.

[For more information, see the article on Investors Business Daily: http://news.investors.com/blogs-capital-hill/112012-634082-federal-deficit-falling-fastest-since-world-war-ii.htm]

Looking at the data in another format, the following graph leads to the same conclusion. (source: usgovernmentspending.com)

The U.S. usually increases its deficit during a recession. We then “grow our way out” of deficit as the economy improves, transfer payments (welfare) decrease, and tax collections increase. However, this time the public feels that it is different. The Great Recession created such a large deficit that we are afraid that we cannot grow out of it.

We are now getting data that suggests otherwise. We may be growing out of our deficit as we have always done.

Economic growth for the third quarter was higher than expected. The Bureau of Economic Analysis (BEA) increased its estimate from 2 percent to 2.7 percent. This is a substantial increase of almost 30 percent over the previous estimate. While this is still a slow rate of growth, it contributes to the improved deficit ratio in the previous graphs.

Here are some of the engines of our current economic growth: housing starts, the service sector and nonfarm employment. The Dallas Fed produces easy-to-read graphs that tell the story.

Housing starts and permits are rising:

The service sector, which is about 80 percent of our economy, has improved:

Nonfarm employment is gaining traction:

The net result may be that we are growing our way out of a recession as we have done in the past.

Granted, we need to control our spending, and everyone hopes for a bipartisan agreement on the budget. Almost 80 percent of the investment advisors surveyed by the Financial Services Institute expect such a compromise – although at the last minute. It sounds as though professional money managers see beyond the bad news story of the fiscal cliff. When they see graphs of shrinking deficits, they may have even more confidence in the market.

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