By Ben Strubel of Strubel Investment Management
When you hear the word austerity you typically think of the measures being taken in Europe, the UK, and Australia. You think tax increases, layoffs of government workers, gutting the social support system, cutting health care and pension benefits, etc. These types of cuts were widely encouraged by the IMF and the EU, who continue to believe the fantasy that a procyclical response (that is cutting government spending while household are cutting spending) will somehow result in growth. The results have been all too predictable for anyone with a basic grasp of economics, markedly slowing economies and continued deterioration of budget deficits.
Chris Hohn the founder and manager of TCI Fund Management was the star speaker at this year's London Value Investor Conference, which took place on May 19th. The investor has earned himself a reputation for being one of the world's most successful hedge fund managers over the past few decades. TCI, which stands for The Read More
In the US we have escaped the austerity bug (or so we think) and the government continues to run large enough budget deficits that provide a moderate but still grossly insufficient countercyclical fiscal response.
However, the recent budget cuts at the Department of Defense (“DoD”) just represent austerity in a different form. While the budget cuts don’t fit the mold of what you typically see in austerity measures it still represents at drop in government spending at a time when spending is absolutely crucial to support the economy. The question of what that spending should be on is of course a social question. From an economic perspective a $45,000 salary paid to a soldier is the same as a $45,000 salary paid to a teacher. It is a social question of whether we wish to have more teachers or more soldiers.
If the cuts to the DoD budget were offset with additional spending elsewhere such as on education, infrastructure, or tax cuts the net result would cancel out but simply cutting spending will impair the economy. Just ask Leon Panetta the Secretary of Defense.
Make no mistake, the savings we are proposing will impact all 50 states and many districts across America, this will be a test of whether reducing the deficit is about talk or action.
Right up front we have direct job losses from soldiers that will be laid off over the coming years. The Army will lay off 75,000 troops while the Marine Corp will lay off 20,000. That is almost 100,000 veterans we will be casting off in to the worst job market in years.
Next we have the pay freezes starting in 2015 and the announcement that retirees will pay higher fees for their healthcare. That means a drop in economic activity as retirees will have to cut back on spending (say going out to eat) to cover their increased healthcare co pays. That will mean a loss of jobs in the private sector as demand falls.
We also have the loss of private sector jobs at defense contractors. The Air Force plans to eliminate six tactical and one training squadron. That means lower orders of new aircraft and less money spent on maintenance. So how will contractors respond? Simple, they will lay off some employees who would have been hired to do the work. They might cut production shifts or reduce hours at plants as well. The Navy plans to retire seven cruisers and some fleet support ships while delaying the purchase of several new vessel notably a submarine and two LCS ships. Again, how will the private sector respond? More layoffs, that extra production shift is no longer needed. Maybe a factory or two is idled for awhile meaning a loss of income for workers.
All of this would be fine; perhaps we do not need a military as big as we had, if the government then spent the money it “saved” from the DoD cuts elsewhere. Those 100,000 soldiers and thousands of private defense contractor workers will need jobs. Where will they get them? Unfortunately the answer is they won’t.
While proposals to engage in typical austerity measures like cutting Medicare, Medicaid, Social Security or raising taxes on the poor or middle class typically raise strong objections from those who examine their economic impact it is a shame that these DoD budget cuts which are simply austerity masquerading by another name haven’t raised a similar cry.
Disclosure: Long LMT