Posted on Wed, Nov. 23, 2011
last updated: November 23, 2011 05:56:53 PM
WASHINGTON — This week's failure by Congress to reach a deficit-reduction deal is likely to have negative short-term and longer-term economic consequences. The failure puts more headwinds in front of the sluggish U.S. economic recovery, whereas a successful deal would have created a significant tailwind to give it a boost.
When Congress avoided a debt default over the summer through a compromise that created the so-called supercommittee, it charged the bipartisan panel with finding at least $1.2 trillion in deficit cuts over the next decade before a Nov. 23 deadline. That's days before one of the most important stretches for the U.S. economy — the holiday season, when consumer spending drives everything. The panel's failure isn't likely to spur consumer confidence.
"It was ill-timed to begin with, to pick Nov. 23 and to actually come out empty. They could have been superheroes and instead they were super zeros," said Stuart Hoffman, chief economist for PNC Financial in Pittsburgh.
By failing to agree even on extending the 2 percent payroll tax holiday that has been in effect this year, lawmakers have added a huge dose of uncertainty to 2012 and shaken business and consumer sentiment. If the payroll tax cut holiday isn't extended, it's sure to retard growth, beginning in just a few weeks.
"That to me probably cuts half a percentage point of economic growth next year," said Hoffman. He now expects growth in the range of 2 percent, so slow that the economy is vulnerable to tipping back into recession. "It's on the knife's edge of the so-called stall speed. The lack of any resolution both adds to the uncertainty, increases the odds that the tax won't get extended into next year and goes to show that our political leadership is so hopelessly divided."
Similarly, Barclays Capital Research, an arm of the London-based banking giant Barclays, projected Wednesday that failure to renew the payroll tax holiday will shave a full percentage point off of U.S. economic growth during the first three months of 2012 and another half a point off of the second quarter.
Lawmakers also blew the chance to differentiate the United States from Europe, which is embroiled in a widening debt crisis. Had America put itself on course to fix its fiscal challenges, that could have provided a huge boost of confidence and juiced an economy that's shown signs of sparking back to life several times this year. As it stands, Europe appears headed into recession, which will hurt U.S. exports, a driver of growth.
Because the dollar is the world's reserve currency, the U.S. economy is still viewed as the safest investment haven amid global financial turmoil. The failure to address our mounting debt has not yet resulted in investors demanding higher returns in exchange for buying U.S. government bonds.
"We're the best-looking horse in the glue factory," said Rudy Penner, a former director of the non-partisan Congressional Budget Office.
At some point in the future however, if Congress fails to shore up U.S. government finances, financial markets could demand the kind of brutal reforms here that they've forced on European nations such as Greece and Italy.
On Wednesday, Spain was forced to pay investors an interest rate of almost 6.7 percent on its 10-year bond — just under the 7 percent level that prompted European Union intervention and costly rescue packages for Italy and Greece. Investors even shied away from the safe haven of German bonds, potentially a sign that investors fear things will only grow worse and are avoiding Europe altogether.
Today's Europe offers a chilling glance at America's potential financial and economic future if annual federal budget deficits — $1.3 trillion in fiscal 2011 — and $15 trillion in total national debt aren't addressed soon.
"I think the most likely outcome is that we won't fix up our long-term problems without some sort of sovereign debt crisis," said Penner, now a senior researcher at the Urban Institute, a center-left think tank. "If we stay on the same path, there will be one."
Because the supercommittee failed, the nation faces $1.2 trillion in automatic federal spending cuts, but not until after next year's elections.
"Any direct impact on economic growth should be muted due to the relatively small size of the automatic deficit reduction measures. Cuts are slated to begin in January 2013 and are spread out over eight years," economists at Wells Fargo Securities in Charlotte, N.C., wrote in a Nov. 22 special commentary.
Still, some lawmakers are busily trying to undo the very spending cuts on defense and health care they ordered if the supercommittee failed. While President Barack Obama has vowed to veto any such rollback, the effort further undermines investor faith in Washington.
Credit-rating agency Moody's Investors Services warned Wednesday that any undoing of the mandatory $1.2 trillion in deficit cutting would lead it to downgrade U.S. government bonds.
For all the talk in Wall Street and Washington about how the economy craves certainty, they supercommittee effectively guaranteed at least another year of uncertainty.
"The deficit reduction talks were geared toward reducing the deficit, but many also viewed the group as a key opportunity to extend the Bush-era tax cuts and other stimulative fiscal policy measures," the Wells Fargo economists wrote, noting that a number of pro-business tax breaks are also now in jeopardy. "The breakdown of the committee's talks now leaves these policies set to expire."
Allowing the Bush-era tax cuts to expire and return to their levels of the late 1990s appeals to some politicians, for that would generate some $3.6 trillion in revenue to help close deficits by 2021, and they argue that those higher '90s tax rates didn't dampen the booming U.S. economy back then.
But Obama and most Democrats want to retain the tax cuts for all but the wealthy, and Republicans want to retain them for everyone. So letting them expire appears unlikely.
"I just think that's an absurd idea. Both political parties strongly want to continue the tax cuts for the middle class," said Penner, the Reagan-era CBO director. "I'd be shocked out of my mind if we actually let the whole thing expire."
Which leaves the government debt at $15 trillion and growing fast; Obama's February budget envisioned it growing another $9 trillion over 10 years. On many levels, the supercommittee's failure deepens the economic challenges facing the nation.
"We're on a path to financial suicide, and we didn't steer off that path," said Hoffman of PNC Financial.
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