Federal budget cuts could put the economic recovery at risk, according to a new Goldman Sachs report. There's no shortage of alarmism directed toward investors.

Slight upticks in the price of food or oil -- or even a garden-variety slowdown in the consolidation phase of an economic recovery -- are enough to set off howls of an imminent doubled-dip recession.

But ironically enough, real threats to the budding economic recovery often garner dismissive attitudes instead.

The hostile response to a recent report by investment bank Goldman Sachs (GS), which highlights the risk of a dramatic cut in government spending just as the economy gains momentum, is the latest case in point.

Modest Cuts, Big Potential Losses

The argument is straightforward enough. "Fiscal drag is quickly re-emerging as a focus, only a couple of months after an agreement to extend tax cuts and unemployment benefits appeared to have neutralized most of the drag from federal fiscal policy for most of 2011," Goldman Sachs analysts wrote. "We see federal spending cuts as the most important near-term risk."

The analysts admitted that the proposed cuts were modest in size. They call for shaving off about $25 billion of spending in 2011 and $50 billion in 2012.

But the suddenness of the slashing could hit GDP growth hard in the near term, even if spending leveled off in the long run.

"Since the cut would be phased in abruptly, it could result in a drag on growth in Q2 by as much as one percentage point, but would quickly fade over the next two quarters as spending stabilizes at a lower level, with little effect versus current policy on the rate of real GDP growth by year end," the analysts wrote.

The British Example


Plenty of commentators viewed the report as a devious Goldman Sachs attempt to play politics and arm Democrats with talking points as the debate over government spending heats up. But investors would be wise to ignore the political rhetoric and look at the evidence instead.

In the U.K., Prime Minister David Cameron also took a hawkish stance on spending and made deep cuts. While Cameron's tough talk was well received initially, the British economy lost major momentum as a result and is now on the brink of a second downturn.

The U.K. admittedly had far less room to maneuver than the U.S. does. Speculators were hammering the British pound in the wake of the European debt crisis, and a run on the currency was a real risk at the time. But in both countries, demand-destroying cutbacks could stall recovery at a critical juncture.

Indeed, there's evidence that cutbacks at the state and local levels already are having an outsize impact on U.S. economic growth.

Looking through the revised fourth quarter GDP data released Friday, TD Economics analysts noted that government consumption was notched down to minus 1.5% from minus 0.6%, with the revision focused at the state and local levels.

"This category tends to have a relatively small influence on GDP as a whole, but in today's release it did account for 0.2% percentage points of the downward revision in the GDP estimate," the analysts wrote.

Look Past Doomsday Scenarios

At a time when government spending is still picking up some of the slack left by still-dampened private demand, it's hardly shocking that government pullbacks are having a bigger impact then they would in ordinary times.

Over-the-top doomsday scenarios get plenty of attention. But investors should keep a closer eye on more measured arguments like Goldman's instead.


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Dereck

Major Fraud Alert


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May 29 2011 at 1:01 AM Report abuse rate up rate down Reply
mullermugs32

As Goldman Sachs just was charged in a trading scheme in todays headline.

March 01 2011 at 1:08 PM Report abuse +1 rate up rate down Reply
mullermugs32

I thought consumers were the biggest factor in the GDP? As far as the UK, they never were really out of the woods to begin with.

March 01 2011 at 9:33 AM Report abuse +1 rate up rate down Reply
george3373

Is this a serious analysis? 25 billion of a 3.7 trillion budget and a 14 trillion economy. Get real this is not even a rounding era. Who is the statistician at Goldman who reviewed this BS.

March 01 2011 at 9:24 AM Report abuse +1 rate up rate down Reply
fred

Some of this investment advice rivals the "chicken littles" of the "save the earth" green people. Some people are like monkeys at the zoo: when they don't get enough attention they rattle the bars on the cages......

February 28 2011 at 11:28 PM Report abuse rate up rate down Reply
scottee

let the recovery stall....stop spending in Washington!
only smaller government, fewer and simpler taxes and free markets will create jobs....and government jobs don't count.

February 28 2011 at 7:01 PM Report abuse +2 rate up rate down Reply
swmdad1

Cuts should be modest, and somebody needs to start working on jobs. If we cut too much we will be right back at the brink of disaster again. In the past in times of crisis the top 5 percent payed 70-90 percent income taxes. The high rate forced them to invest and expand operations to qualify for tax breaks, which created jobs. Now they dont pay over 15 percent and most corperations pay none at all. And they are just sitting on the capital. Trickle down is a failure, sorry
Mr Reagan you broke the American Dream.

February 28 2011 at 6:09 PM Report abuse -4 rate up rate down Reply
chstr330122

Is this not the same Goldman that gave us the current and former tresuary sectretaries and half of the rest of the people that caused this problem in the first place? Now they want to tell us to leave Obamas (and thier0 money alone!

February 28 2011 at 3:17 PM Report abuse +4 rate up rate down Reply
larry & gail

Just CUT the damn budget and spending and lets find out

February 28 2011 at 3:17 PM Report abuse +5 rate up rate down Reply
puzzleguy1

First, it is a given that gov't spending MUST be cut. So, that leaves us with the questions: (1) overall, cut how much? and (2) specifically, cut what? Make no mistake, if too much money is taken out of circulation, we are inviting a double-dip recession. That's why the president has it right when he said cut with a scalpel, not a meat cleaver. So, politicians, especially elected Tea Party types, had better think THREE times before going after draconian cuts. What can be cut? Get us out of Iraq AHEAD of schedule. Nothing is to be gained by lingering there as we have done all that we can do to give the Iraqi people a chance to succeed. Then, as a general principle, cut in places that will have the smallest effect on jobs. For example, reduce funding for NEA. I'm sure other contributors can come forward with targets for cuts that follow this principle. The idea is to keep as many people with jobs working so they can earn and SPEND.

February 28 2011 at 2:36 PM Report abuse rate up rate down Reply
1 reply to puzzleguy1's comment
Trevor

Draconian? $60 billion is less than 2% of the overall budget. Let's say your personal budget required 40% borrowing to maintain, as the government's presently does. If your wife suggested you cut your spending by 2% would such a proposal be "draconian"? Or "a dfecent start, but woefully insufficient"?

February 28 2011 at 4:51 PM Report abuse +3 rate up rate down Reply