Question: how it is possible for real disposable incomes to fall by 5.3 per cent, yet personal consumption to rise by 3.2 per cent? (That’s on an annualised basis, by the way). It smells of debt, doesn’t it? Or consumers finding new confidence, or – dare one utter the words – of a bubble in the making. Yet this is what happened in the US during the first quarter of this year.

Here is another question. How is it possible, under the current economic conditions for government spending to be cut by 4.2 per cent in Q1 (again that’s annualised), while the economy expanded at an annualised rate of 2.5 per cent? Yet this is what has happened in the US.

It’s an odd thing. We keep hearing about how US government debt is unsustainable, and how Obama is leading the US economy over the steepest and most terrifying of fiscal cliffs.

The truth, if anything, is that the fiscal cliff is more like one of these things that count for hills in East Anglia. The US stares from the top of the dizzying heights of a molehill.

Capital Economics explained it thus: “The 7 per cent decline in real government expenditure over the past couple of years is very unusual. Expenditure did decline by 11 per cent in the 1950s after the Korean war ended, by 7 per cent in the early 1970s after the Vietnam war ended…Nevertheless, that makes the current decline already the joint second biggest since the end of World War II, with the sequestration cuts still to take effect.”

Republicans and Democrats are busily staring at each other like gun fighters at dawn, unwilling to even hint at compromise, which has meant the expiry of George Dubya’s tax credit, and forced budget cuts. Troop withdrawals from Iraq and Afghanistan have also helped to lead to a sharp fall in defence spending.

Even so, the figures are surprising. Capital Economics said: “After accounting for measures to raise revenue, such as allowing the payroll tax cut to expire, as well as spending cuts, the decline in the structural Federal budget deficit has been dramatic. From 7.0 per cent of GDP in fiscal year 2009, that deficit narrowed to 2.5 per cent in 2013 and, according to the CBO’s projections, will be only 1.0 per cent in 2014. By next year, most of the remaining Federal budget deficit will be explained by the lingering cyclical weakness.”

So the US is experiencing what we in Europe call austerity.

The large fall in disposable income was mainly down to expiry of the tax credit.

So why, oh why, or indeed how, oh how, did the US manage to grow at 2.5 per cent in the first quarter?

Answer: well it can surely be no coincidence that the quarter also saw the Dow Jones and S&P 500 hit new all-time highs. US house prices are on the mend too, and that did no harm.

It seems that Americans would rather see equity and house values rise, than earn more money – at least that is the story of Q1.

It is a triumph of QE. Quantitative easing, which is having the effect of pushing up on asset values.

Look at the global economy and it is hard to see why equities have performed so well this year. Look at QE, and the explanation becomes clearer.

Does this mean what they call monetary policy – that is to say central banks playing with interest rates and bond buying – can make up for the effects of austerity? The experience of the US in Q1 says it does.

But then again, it is just a quarter. This week alone may see data that tell another story. See: Data week in the US. In the battle between austerity/stimulus/monetary policy, snapshots are not very reliable.

The real cliff hanger in the story of the US economy relates to what effect austerity will have during the rest of this year.

© Investment & Business News 2013

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