Daily: In all scenarios, GDP will be impacted by the fiscal cliff
According to recent estimates by Goldman Sachs, the US economy is already at stall speed, with GDP growth for Q4 expected to be an anemic 1%. Any further cuts to growth beyond this due to the fiscal cliff in 2013 would cause a recession.
But we also know two things based on the recently released ISM manufacturing numbers upon which Goldman’s downgraded growth expectations for Q4 are based. First, as I outlined in a post for silver and gold members, the fiscal cliff has already negatively impacted new orders. The reason the ISM manufacturing survey was negative had much to do with poor numbers for new orders and employment, both of which were affected by caution associated with the fiscal cliff. Output was higher in November than October. Second, as Goldman pointed out, all of the inventory build of Q3 was reversed out in Q4 as the caution associated with the fiscal cliff caused manufacturers to work off inventory rather than go into 2013 with a high level of inventory that would make them vulnerable to a fiscal cliff-induced downturn in demand.
GDP has already been impacted by the fiscal cliff.
What about the actual fiscal drag. A few months ago we pointed to a Credit Suisse paper that outlined four fiscal cliff scenarios that ranged from a 0.9% to a 3.8% drag on GDP growth. And since Goldman is expecting a 1.0% GDP growth print for Q4 2012, this would mean that US growth would be near recession under every single scenario that Credit Suisse presented in August. Goldman did up a similar scenario chart in October that FT Alphaville carried. Here, the question is how much impact the cliff would have in each quarter through Q4 2013. The answer Goldman came up with was for an impact from just under 2% to well over 4% throughout 2013 if all fiscal cliff provisions failed to be resolved (see chart).
Bottom line: the fiscal cliff is a real threat to the US economy in 2013 and not reaching a resolution would be catastrophic to growth in the US as austerity has been for Greece, Spain and Ireland. The question is whether an agreement will be reached. Since this is a political question, the answer is unknowable. I would like to think we will see a resolution with a non-recessionary outcome but we can not be sure this is going to be the case.
Nevertheless, the implications of all of this have been clear for some time as the articles below attest. Some of these were written a few months ago. But all are relevant to the present negotiating situation today and speak to the political quagmire that the US finds itself in. What I find interesting is the quote from Kevin Logan below, which says that the US will still have a deficit of 6% even in a muddling through scenario, which seems the most likely outcome. To me that speaks to the US deficit as a permanent outgrowth of the private sector’s need to net save, especially in the household sector.
Read Gerald Minack’s piece via FT Alphaville for some interesting thoughts on why the deficit is intractable given the private sector’s desire to net save without resorting to default, writedowns and debt forgiveness. It puts the balance sheet nature of the problem in perspective.
“HSBC reaches a similar conclusion. On a muddling through scenario of some austerity and debt reduction, fiscal tightening would amount to 1.1 percent of GDP in 2013.
But that would still leave the budget deficit in fiscal year 2013 at 6 percent of GDP, one of the highest on record, Kevin Logan, the bank’s chief U.S. economist, said in a report.”
“This one from Goldman economists, showing the projected impact on GDP growth in each quarter from the various provisions.”
“The CBO said economic output would drop by 0.5 percentage point in 2013 if Congress fails to act to avert the tax increases and spending cuts put in motion by an earlier deficit agreement. But the CBO added the U.S. economy would in the longer run return to better growth rates and lower employment. The CBO, the independent budget arm of Congress, said the unemployment rates will fall to 5.5% by 2020.”
“Treasury secretary Timothy Geithner is reported to have offered a set of proposals that include increasing tax rates on the wealthy, a one-year postponement of scheduled cuts in defence and domestic spending, and $400bn in savings from Medicare and other entitlement programmes.
The proposals from the White House – the first to use hard numbers – include a $1.6tn tax increase, a $50bn stimulus package and new presidential powers to raise the federal debt limit without congressional approval.
But based on public and private comments after their meetings, both House speaker John Boehner and Senate minority leader Mitch McConnell – the two most senior Republicans in Congress – brushed aside the proposals as incomplete.”
“deleveraging is happening too slowly across entire economies, because increased savings are a slow way to decrease leverage: much of the little private sector saving that has occurred has been due to asset sales and writedowns, rather than savings.
And this is where we get to a scenario (not a prescription, he pointed out to us by email) that Minack thinks might come about if these indebted countries enter another crisis – but this time, with a much heavier burden than in 2008.”
“There will be no comeuppance in yields if the government eliminated the debt ceiling and the Fed kept rates at zero due to low inflation fears. Just like the market wasn’t worried about QE2 ending (and all the persistent fear mongering about rates surging) or the S&P downgrade or the debt ceiling debates last year. Yields remained low through all of these supposedly disastrous events. We’ve literally heard this same prediction based on the same false understanding time and time again.”
“I don’t think we’re ready to make a baton pass just yet from full public sector to private sector driven recovery. Yes, private investment is growing at a nice clip for now and we’re still running a deficit that is substantial (though lower than it was), but that doesn’t mean there’s no downside risk here. I think the economy remains extremely fragile and is still recovering from the consumer driven credit crisis. The balance sheet recession is still very much alive as the most recent NY Fed report on household credit showed. So a substantial decline in the government’s deficit could seriously impact aggregate demand and help contribute to a pullback at the consumer level. “
“For we have our own currency — and almost all of our debt, both private and public, is denominated in dollars. So our government, unlike the Greek government, literally can’t run out of money. After all, it can print the stuff. So there’s almost no risk that America will default on its debt — I’d say no risk at all if it weren’t for the possibility that Republicans would once again try to hold the nation hostage over the debt ceiling.
But if the U.S. government prints money to pay its bills, won’t that lead to inflation? No, not if the economy is still depressed.”
“Advocates of extensive tax expenditure reduction argue — correctly — that all deficit reduction choices involve substantive costs and are politically difficult. They then suggest that, when compared to other possibilities, substantially more cuts may be doable than the Congressional research numbers suggest.
Maybe, but I think that’s unlikely when compared to the alternative of restoring the topmost tax brackets to their Clinton-era level.”
““The ‘Fix the Debt’ CEOs are trying to pass themselves off as noble leaders who are willing to compromise in order the save America from financial ruin,” says report co-author Scott Klinger. “In reality, the campaign is a Trojan horse concealing massive corporate tax breaks that would make our debt situation much worse.””
“Business leaders, who generally didn’t support President Barack Obama’s policies in the past four years or his re-election bid, weren’t in a more-gracious mood after the results were in. Today’s decline in the U.S. stock markets, the biggest since June, didn’t help.”
“Like Capital Economics and many other research units in the financial world, Bank of America presumes every dollar of tightening would drain the economy by about the same amount, although it says a bigger effect is possible.
“The economic impacts could be worse than our baseline assumptions,” said Michael Hanson, an economist with the bank in New York.
Eichengreen and others who have studied economic data from the Great Depression, another time central banks were constrained, found the drag from a tightening of fiscal policy was much higher at the time. Eichengreen thinks currently the so-called multiplier is about 1.7, in line with the upper range of the IMF’s estimate.”
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