The Federal Reserve has provided an ocean of liquidity since the great recession that followed the global financial crisis through the QE1, QE2 and QE3 programs. In fact, the Fed’s balance sheet has grown significantly due to these programs. Total assets have soared from just $869.0 billion in August 2007 to well over $3.0 Trillion as of February 20, 2013.

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Source: The Federal Reserve

Equity prices have increased strongly in line with rising liquidity. The following chart shows the correlation between Fed’s growing balance sheet and the S&P 500:

Source: The Week Ahead, February 25 – March 1, 2013, CIBC World Markets

Related ETF:

SPDR S&P 500 ETF (SPY)

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The U.S. Federal Spending for Fiscal Year 2012 was about $3.5 Trillion.On a percentage basis, healthcare and social security payments accounted for 45% of total spending. Defense expenditures amounted to 19% of total spending. Net interest paid on outstanding public debt added another 6% according to data provided by Congressional Budget Office (CBO).

U.S. Federal Spending – FY 2011

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Source: Wikipedia

The public perception on U.S. spending is that the Federal government is too large and that spending is out of control leading to deficits year after year. All the conservatives and even some democrats would agree that government spending has to be reined in in order for the economy to move forward.

In reality how does the U.S. government spending compare to other G-7 countries?

U.S. government spending is not high compared to other G-7 countries. This is because unlike other countries, the Federal government in the U.S. spends most of the spending and not the state and local governments. In Germany or Japan for example, the sub-national governments dole out much of the spending pie. Hence even though the U.S. Federal spending as a share of GDP looks higher among G-7 countries the actual spending by other G-7 countries is much higher.

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One of the suggested solutions put forth by conservatives is drastically cutting down the size of the government. Austerity is the new buzzword among the proponents of a lower government who propose to slash government services such as social programs and other entitlements. Despite the failure of austerity programs in many European countries, conservatives in the U.S. steadfastly believe that austerity is the panacea for solving the U.S. deficit. Here again their proposed solution is incorrect and bound to fail. This is because all government spending(federal, state and local) in the U.S. as a percentage of the GDP is still the lowest among G-7 countries as shown in the chart below. So slashing government spending when the country is barely recovering from the worst recession in decades is not a sensible strategy. Instead of focusing on slashing desperately needed social programs at this time, lawmakers should try to stimulate economic growth by implementing growth-oriented policies.

Source: US in Debtors’ Prison: A Life Sentence? by Emanuella Enenajor and Andrew Grantham, Economic Insights, January 29, 2013, CIBC World Markets