Obama's Budget Cuts: Less Than Meets the Eye, Thankfully

The latest bout of brinkmanship in Washington, D.C., is over the federal budget. President Barack Obama unveiled his proposed cuts earlier this week with plenty of tough talk about fiscal responsibility, and a parade of high-profile Republicans lined up predictably to say the spending reductions fell short of making a real difference.

Thankfully for American workers and investors, the Republicans have it right.

With presidential elections approaching in 2012, the White House is revving up its PR campaign in a move to portray itself as tough on government spending. The first glimpses of the approach were unveiled during the State of the Union address, when few concrete measures were described, despite plenty of soaring rhetoric.

While taking a tough posture, the proposals outlined this week are similarly fluid.

"President Obama's Fiscal Year 2012 budget epitomizes his shift from a policymaking strategy to a public relations strategy," analysts at political risk consultancy Eurasia Group wrote in a note to clients. "The shift is intended to appeal to independent voters and preserve his current lead going into the 2012 election by taking few risks rather than proposing an ambitious agenda for congressional action."

Savings Based on Unrealistic Assumptions

Despite presidential lip service about belt-tightening, forecasts still put government deficits at $1.6 trillion, or 11% of GDP, "which makes clear that the president's spending-cut proposals do not add up to much in the near-term," the analysts note.

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And while the outline over the medium term shows a substantially shrinking deficit, much of that drop is built on unrealistic gimmicks.

It assumes, for example, that the Bush tax cuts for the wealthy will be allowed to expire in 2013 and that war spending will decline sharply based on a troop withdrawal time line that Eurasia Group analysts see as unrealistic.

Several hundreds of billions in reductions are supposedly to be found in initiatives like eliminating tax breaks for oil, gas and coal companies, and capping itemized tax deductions for the wealthy. While such changes are easy to propose, attempts to accomplish all of them have hit roadblocks on Capitol Hill before, the analysts note.

But odd as it seems, investors should welcome this particular version of political maneuvering specifically because it is likely to lead to such small results. Using superficial cuts to provide political cover may be exactly what the economy needs. Major slashing of government spending could cause consumer demand to evaporate at a time when the economy is finally starting to show some self-sustaining momentum.

A Cautionary Tale From Britain

Indeed, the brutal toll that major pullbacks in government spending can take on an economy trying emerge from a recession is on full display across the Atlantic.

British Prime Minister David Cameron initially won plenty of accolades for promising to get the U.K.'s fiscal house in order. But Cameron's grand $128 billion, four-year plan of spending cuts and tax hikes is looking much shakier now. Instead of expanding as economists had forecast, Britain's economy unexpectedly contracted in the last months of 2010, and some now fear a double-dip recession may be in the cards for that nation.

In fairness to Cameron, Britain may have had far less choice about budget-cutting than the U.S. has. The British pound faced massive pressures last year after speculators hammered the euro during the heights of the European debt crisis. By contrast, despite all the hype about the dollar facing an immediate crisis, the greenback remains the world's reserve currency of choice. That gives the U.S. far more latitude than Britain could hope for.

And President Obama's strategy of deflecting more severe budget-cutting pressures through token pullbacks as the economy recovers may be just what's needed.