Local governments have five choices

Van Hoisington and Dr. Lacy Hunt are analysts worth listening to. In John Mauldin’s latest Outside the Box letter, they present seven reasons why economic growth in 2011 will be lower than 2010:

First, fiscal policy actions are neutral for 2011. Second, state and local sectors will continue to be a drag on the economy and labor markets in 2011. Third, Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy. Fourth, while consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable. Fifth, expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011. Sixth, housing will continue to be a persistent drag on growth. Seventh, external economic conditions are likely to retard U.S. exports.

They make no excuses for Keynesian economics, stating quite bluntly that stimulus has not worked (nor has it ever worked):

If fiscal policy becomes focused on  long-run considerations (e.g. deficit reduction) economic conditions will improve over time.  But, if fiscal policy remains focused on shortterm stimulus, the economy’s prolonged underperformance will persist since the government expenditure multiplier is less than one, and possibly close to zero.

Options they see for local and state governments are not positive for economic growth:

To reign in these financial imbalances,  state and local governments have five choices: (1) cut personnel; (2) reduce expenditures including retirement benefits; (3) raise taxes; (4) borrow to fund operating deficits; or (5) declare bankruptcy. All retard economic growth.

QE2 is seen only as exacerbating the growing income disparities in the country:

Clearly, Fed actions have affected stock  and commodity prices. The benefits from higher stock prices accrue very slowly, are small, and are slanted to a limited number of households.  Conversely, higher commodity prices serve to raise the cost of many basic necessities that play a major role in the budget of virtually all low and moderate income households.

The recent retail sales boost is not positive in their opinion:

When job insecurity is high, and defaults, delinquencies and bankruptcies are at or near record levels, a drawdown in the saving rate would seem to be an unlikely event. This development is certainly viewed favorably by retailers but the issue is whether the economy’s future is better served by using the funds to make mortgages current, pay other debts and prepare consumers for potential emergency needs. Thus, the lowering of the saving rate is  similar to running monetary and fiscal policy to meet short-run needs while ignoring long-term consequences.