Is the US heading towards another recession? Kohler

The trouble with kicking the can down the road is that you eventually encounter it again. That’s what’s happening to American fiscal policy at the end of this year.

There are actually a whole lot of cans that all come together on January 1, 2013: the end of the Bush tax cuts, the expiration of the 2010-11 payroll tax cut, expiration of emergency unemployment benefits and most importantly, $1.2 trillion of spending cuts that Congress stipulated would kick in automatically because the committee charged with finding agreed spending cuts couldn’t agree.

All up, the US economy is facing its biggest fiscal contraction ever – one large enough to cause a recession in 2013. What’s more, the markets don’t seem to be taking any notice of it, perhaps because they don’t believe Congress will actually let it happen.

It seems a reasonable bet that Republicans and Democrats will agree to dodge a recession, but history has shown that anyone who assumes sensible politics in Washington is taking a risk. In any case, the US has to deal with its massive debt burden at some point.

Without the legislated cutbacks, US debt will rise from 70 to 88% of GDP by 2022; with them, it falls to 61%.

As the Committee for a Responsible Federal Budget says: “Continuing all the expiring (tax cut) provisions and cancelling the sequester without a plan in place would be a dramatic move in the wrong direction and should be considered a non-starter.”

The size of the looming fiscal contraction is the subject of hot debate. The CRFB calculates the cost of the things due to kick in on January 1 at $1 trillion over two years, or 3.5% of GDP just in 2013. Between 2013 and 2022 the total cost is $7.5 trillion.

However Morgan Stanley’s David Greenlaw has calculated that the impact of the tightening in 2013 is more like 5% of GDP because of the conversion of fiscal year measures into the calendar year.

Even if you apply an “ultraconservative” fiscal multiplier, according to Greenlaw, that will lead to a disastrous recession in the US next year.

Just about every political commentator and economist in the US is assuming that legislation will eventually be passed to avoid what they’re calling the “fiscal cliff”, but that won’t happen before the election in November, which leaves very little time to do something before January 1.

Says Greenlaw: “Conceivably, it could be just as difficult to break through the political gridlock after the election as it has proven to be in recent years. Thus, the range of possible outcomes is very wide and a high degree of uncertainty is likely to prevail right up to – and maybe even through – the November election.”

In the Wall Street Journal recently, the Professor of Public Policy and Economics at Princeton, Alan Blinder wrote: “In the absence of progress between now and Election Day, Congress will have about eight weeks left – including Sundays, Thanksgiving, Christmas and New Year’s Eve – to either (a) find a solution to the long-running fiscal battle or (b) kick the can down the road again.

“Bet on (b). Also bet that the agreement will come just before the bubbly flows on New Year’s Eve. An outcome like that is far more likely than falling off the fiscal cliff. But my point is that finding a clever way to kick the can down the road again is becoming a bigger and bigger challenge. And Congress has barely coped with previous such challenges.”

In other words, bet that the US won’t go over the fiscal cliff, but don’t bet your house. And in the meantime, there will be plenty of uncertainty and market wobbles.

This article first appeared on Business Spectator.