When supercommittees fail

Advertisement

Check out this great chart from Abnormal Returns this morning:

It says all sorts of wonderful things, including that it’s much more difficult to make successful bearish forecasts than it is a successful bullish ones. But the point I wish to make this morning is about the big bounce in positive economic surprises since August in the US (which, as you can see, has been completely ignored by the US bond market).

For the past three months, my base case for the US economy has been a 2012 recession. The first reason was that I was also expecting a European recession so the fallout from that was always going to have serious consequences for US in the strengthening of its dollar and weakening of its export earnings. But the primary reason was the 2011 fiscal cuts scheduled after the August debt-ceiling debacle, hitting, as they were, an economy traveling at little better than stall speed.

Advertisement

Last week’s European ZEW survey confirmed the first half of this forecast:

But there is better news on the US fiscal front. It is becoming increasingly obvious that the congressional supercommittee appointed the task of cutting the US budget deficit is unable to reach agreement and is set to announce its failure as soon as tomorrow, according to the Washington Post.

Advertisement

Most of the estimates for the likely fiscal chopping of the supercommittee were in the 1- 1.5% of GDP range for 2012. The imminent failure of the committee is, therefore, prima facie, good news. To my mind, the notion that the US should be taming its deficit amid a balance sheet recession and private sector deleveraging is Austrianism gone mad (and I adhere to Austrian principles in some ways).

But is it as simple as that? This is politics so, of course, no. By year end we face the following:

Democrats and many economists consider particularly urgent the need to extend jobless benefits and the one-year payroll tax cut. With national unemployment stuck at 9 percent, and the ranks of the long-term unemployed at record levels, the government is providing up to 99 weeks of support to about 3.5 million people.

Meanwhile, the payroll tax cut, enacted last December, allows most American workers to keep an additional 2 percent of their earnings, a boon to tight household budgets as well as the economic recovery. Economists at J.P. Morgan Chase recently estimated that if Congress does not extend the two measures, economic growth next year could take a hit of as much as two percentage points — enough to revive fears of a recession.

Advertisement

So, in fact, the failure of the supercommittee actually increases the possible fiscal cuts for 2012. And the bad news does not stop there. If the supercommittee fails:

…it would lose special procedural powers to push a tax-and-spending plan through a bitterly divided House and Senate, leaving congressional leaders without an easy path to compromise on the expiring provisions — and a potentially nasty holiday-season fight on their hands.

“We don’t have the answers,” Sen. Richard J. Durbin (Ill.), the No. 2 Democrat in the Senate, conceded recently as it became evident that the panel’s effort had stalled. “The supercommittee was put in place” to develop “a strategy to take us through the election” by resolving the toughest outstanding budget problems, he said. “If they don’t succeed, then we have to address these issues.”

In short, the decisions revert to the same partisan politics that created this problem in the first place. But there is this one hope:

Advertisement

While December is shaping up as a critical month, lobbyists and senior aides say they expect lawmakers to put off some decisions until next year. For example, although the inflation adjustment for the AMT is set to expire on Dec. 31, most people would not have to pay the higher tax until April 2013. That leaves plenty of time for Congress to fix it.

Dozens of expiring tax breaks for businesses and individuals, collectively known as the “tax extenders,” also could be revived retroactively.

In short, as much as I’d like to change my base case for the US in 2012 on its recent promising data, I can’t. It may be that markets have been surprised by positive economic data flow in the US over the past few months (outside of the bond market) but I have little faith that we’ll be seeing any positive political surprises in the near future.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.