College football season is fast approaching and like every year, the path to the national championship will largely be decided during rivalry week.  That is the week when most major programs play their arch rival.  Ohio State vs. Michigan, for example.  The build up to the contest, the drama of the game, and the final outcome are all incredibly exciting.  Moreover, the ramifications of victory, as well as defeat, can have a profound impact on the future of a program, its players and coaches.

In my view, it appears to be rivalry week for our political leaders, with the arch rivals being continued economic stimulus vs. government debt reduction.  And similar to the gridiron, the outcome between these diametrically opposed policies will have major implications for our country.

Pregame hype… Just how did we arrive at this critical economic policy battle?  It all began with the mortgage meltdown and subsequent financial crisis, which drove our economy into the worst recession since the Great Depression.  Massive government intervention was required to return our financial markets to some degree of normalcy.  Over the past several months, in the context of this unprecedented stimulus, our economy has started to recover.  Yet, the recovery has been lacklustre, with unemployment stubbornly high and lingering fears of a dreadful “double-dip” recession never far from the economic debate.  And therein lies the backdrop for this epic battle of competing economic policies.

Meanwhile, most major economists agree that removing economic stimulus to focus on debt reduction, at a time when the economy is relatively weak, would likely lead to recession.  But it puzzles me that the economy remains relatively weak despite the greatest stimulus in history.  Moreover, based on the latest quarterly AP Economy Survey, “economists have turned gloomier in the past three months.”  I find this puzzling as well, in the context of very strong corporate earnings in this most recent quarter.

Not surprisingly, corporations, small business owners, investors, and consumers remain cautious regarding investment, hiring, and spending decisions.  In fact, all these constituents are hoarding cash and are continuing to deleverage.  On the surface it seems logical to conclude that removing stimulus would make this situation worse, but I’m wondering if the opposite is true.

Perhaps if the government changed course and got serious about debt reduction then all of these interested parties might actually rekindle the flames of entrepreneurship, and get the economy moving again.

In my view, the side that favors continued stimulus has lost the momentum of public opinion.  Even so, the majority remains sceptical whether the President and Congress can actually produce meaningful reduction in our colossal federal debt.  Stimulus and spending seem more natural to our political process.    Nevertheless, it seems increasingly clear that government stimulus is not the most effective means to create economic growth on a sustained basis.  I don’t believe it ever has been.

The first half of the Great Deleveraging Cycle was brutal, as our financial markets were shaken to their core.  But now the second half is about to start.   And deficit reduction has the ball.

A challenge that will define our future… The enormous amount of pent-up energy, reflected by all-time high corporate cash levels and the deleveraging private sector, is poised to explode.  All it needs is a catalyst.  Meaningful deficit initiatives could be such a catalyst, and it will happen at some point.  Why am I optimistic when so many pundits profess doom and gloom for our country?  According to Arthur Brooks, the president of the American Enterprise Institute, America is a 70-30 nation.  70% favor a free enterprise system, while 30% prefer a more socialistic approach.  And we remain a 70-30 nation even after the worst recession since the depression as well as the backlash against large financial institutions and overpaid corporate fat cats.  Our belief in freedom, opportunity, and the American dream remain steadfast despite these once in a lifetime challenges.  Or, as the most famous sentence in the English language puts it…

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”  Declaration of Independence

That’s what I’m talking about, as my kids would say.  Still the greatest country in the world.

Michael Kayes, CFA