The market seemed to like President Obama’s State of the Union address, taking the Dow Jones above 12,000 this morning for the first time since before the collapse of Lehman Brothers in 2008. However, like Julia Gillard, he is heading off in the wrong direction.

Put simply, the Australian Prime Minister is too worried about the fiscal balance and the US President is not worried enough. Australia’s political obsession with surplus budgets in all circumstances is absurd, as is America’s insouciance about deficits.

Actually Wall Street is more focused on Ben Bernanke than Barack Obama these days and was probably anticipating a supportive monetary policy statement from the Federal Reserve (which is what happened a short time ago — the Fed said it would press on with the $US600 billion of bond purchases announced in November because “progress … has been disappointingly slow”. It was unanimous this time too.)

The centerpiece of the President’s State of the Union speech yesterday was the idea that this is this generation’s “Sputnik moment” — a reference to how the launch of Sputnik 1, by the USSR in 1957, kicked off the space race. It was full of rhetoric about American exceptionalism and the need for innovation, but very thin on concrete measures to reduce the ballooning budget deficit.

He announced a freeze on discretionary government spending, and a $US400 billion spending cut over 10 years. This is nowhere near enough in the circumstances of a deficit that is 9% of GDP and is about one-tenth of what his own Fiscal Commission recommended in November.

In fact the rhetoric of the speech was quite at odds with the situation in which the United States finds itself. The US responded to the USSR’s launch of the first satellite with a “whatever it takes” expansion in public spending directed at beating the Soviets to the moon, which it did 12 years later.

America is already the most innovative nation on earth. That, plus its immigrant culture and the cash raining down from “Helicopter Ben” Bernanke, is why it is recovering from the GFC at all. But the idea that innovation can be improved by government spending is not just bunk, it’s dangerous bunk.

As Spain, Ireland and Greece have found, financial markets can be harsh and fickle masters. It’s true that the US dollar’s status as the world’s reserve currency means America can finance its deficit more cheaply than anyone else and the high birth rate means it has less of a problem with ageing than Europe and Japan, but that doesn’t mean the US is in any position to go in for a 1960s-type government spending splurge in an attempt to out-export China. That will end in disaster.

Meanwhile, back in Australia, the budget is in a wonderful position — heading back into surplus in a couple of years despite one of the world’s biggest and most successful stimulus programs during the global recession.

But you wouldn’t know it. Five billion dollars needed in flood recovery spending and … oh dear, we need a levy. Can’t possibly wait a year or two to go back into surplus. What would Tony Abbott say?

Actually he’s just as bad. “Cut spending elsewhere,” is his answer. How ridiculous: to pay for a one-off flood relief and reconstruction program we have to sack public servants or cut welfare.

If Gillard’s proposed increase in the Medicare levy gets past the Lower House independents as well as the Senate, then spending power will be reduced at the worst possible time for the nation’s retailers. Warwick McKibbin is right: the economy will already be hit by the floods; raising taxes to pay for it will only exacerbate the impact.

*This first appeared on Business Spectator.

Peter Fray

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