The big news in recent days is the so-called “Super Committee’s” failure to agree on budget cuts that will help America avoid a mythical insolvency. Lawmakers have been attempting to push through cuts to the deficit in order to avoid our own Greek moment. And as they fiddle around over something that is not even a risk to the US economy (running out of money), they risk further endangering the already weak economy by cutting spending during a balance sheet recession.
In a recent researc pice Fidelity Investments outlined the current outcomes we face as the debt committee attempts to come to terms (via Fidelity):
Knight: Broadly speaking, there could be at least three scenarios that could unfold and impact the markets.
1. Agreement is not reached
One scenario is that the Super Committee fails to achieve at least seven votes (a majority of the 12 members is needed) on any set of recommendations. Alternatively, the Super Committee may report a bill, but Congress fails to approve it by December 23.
Moody’s Investor Service recently suggested that the Super Committee’s failure wouldn’t necessarily lead to a debt downgrade, but the fact that Congress could not come together to solve problems would certainly not be viewed as a positive step.
2. A Super Committee agreement just meets or falls short of its target
The committee could reach agreement on a bill that reduces the deficit by exactly $1.2 trillion over 10 years or a bill that falls somewhat short of that target. This would avert the budget sequestration that is scheduled to begin in 2013, or reduce its impact.
3. The bill proposed exceeds its target
The Super Committee could reach agreement on a bill that exceeds $1.2 trillion of deficit reduction over 10 years. Many might view this so-called “grand deal” favorably, but most people who are closely monitoring the Super Committee process do not expect such an outcome.
The good news here is that we aren’t on the verge of repeating the debt ceiling mess from earlier this year. The bad news is that this disagreement is beginning to shed doubts on the passage of some sizable spending in the 2012 budget. Namely, potential unemployment benefits and the payroll tax extension. As Goldman Sachs noted last month, failure to pass these programs could shave up to 1% from 2012 GDP (see here for more from Goldman):
“The other key drag on US growth is the tightening of fiscal policy. Our baseline assumption remains extension of the employee-side payroll tax cut and passage of a small business hiring incentive; we do not assume extension of emergency unemployment benefits (although this is a close call), a further expansion of the payroll tax cut as proposed by the President, additional infrastructure spending or aid to state governments, or another foreign repatriation tax break. We also expect the Congressional “supercommittee” to agree on spending cuts and revenue increases that cover part of the mandated $1.2 trillion in savings over 10 years; the remainder will likely come via automatic cuts that take place from 2013. Overall, we view the risks around our assumption of just under 1 percentage point of fiscal drag (excluding multiplier effects) in 2012 as roughly balanced at present.”
That’s a huge hit to an economy that is currently growing at just 2-3%. And as Warren Mosler likes to say, “because we think we’re the next Greece, we’re becoming the next Japan”.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.