Stimulus In Reverse

We are about to face an important test! Can the economic recovery, which is undeniably underway, withstand the reverse of stimulus that not long ago rescued us from the financial crisis. Here's what I mean by Stimulus In Reverse:

• Rising Interest Rates
• Giant Fiscal Cuts (Federal and State)
• Less Monetary Easing
• Expiring Tax Breaks and Increasing Tax Rates
• Increased Fees, Fines, and Every Other Tax Substitute
  
• Diminished Government Support for Home Ownership
• Opening the Mortgage Foreclosure Floodgates
• A Challenging Municipal Borrowing Market
• Reduction of Long term Unemployment Benefits
• Tightening in China
• Worldwide Fiscal Austerity

During the crisis from Fall 2008 - Winter 2010, these monetary & fiscal forces provided a tailwind for the recovery. But now we're entering a phase of policy changes that are turning off the stimulus faucet and efforts to balance budgets. The populous opinion is that the spending is unsustainable. Since the 2010 election, the pendulum is swinging back over to austerity.

The question is whether or not we maintain the positive momentum in the economy, or if we'll slip back to negative growth. I don't think anyone really has the answer. Personally, I think it could go either way. A lot will depend on something called "animal spirits." In other words, consumer and business confidence will be the driver.

If the mood turns sour and consumers hunker down once again, the recent wealth creation in the stock market would suffer a big reduction, growth would dip and unemployment would rise.

In some respects the economy is more vulnerable now that it was in 2008. At that time the Federal government was allowed much more freedom to step in than it would have today. Fed Chair Bernanke and Treasury Secretary Geitner have warned us numerous times of the danger of withdrawing stimulus to fast. But they've also warned us that we're on a collision course if we don't get our fiscal house in order. You might say we're dammed if we do and we're dammed if we don't cut government debt and deficits.

Surely, there is a balancing act going on. If we lean to much over to the fiscal conservatism side we will pull the rug out from under the recovery; on the other hand, if we don't rein in out-of-control government deficit spending we'll face a crisis in the debt markets.

Unfortunately, there is no magic formula that we can use to get the mix of of cuts and stimulus just right. We'll know whether or not if we got it right when the markets and the data tell us. But if the leadership does get it wrong, the big question will be, "What can they do to fix it?"

Obama's 2011-12 budget kicks off a debate that will ultimately prove to be a test if the economy can withstand Stimulus in Reverse.

Related articles:
Goldman Sees Danger in US Budget Cuts
GDP: Economy slows on cuts from state and local government