Monday, August 6, 2012

Weak Economy Wiping Out Last Summer's Deficit Cuts

By JED GRAHAM, INVESTOR'S BUSINESS DAILY
Posted 06:46 PM ET
On the anniversary of its stunning U.S. credit downgrade, Standard & Poor's faced ridicule because of how far Treasury's borrowing costs have fallen since then.
But by another measure, the credit ratings agency appears to have had a point when it dismissed the significance of last August's Budget Control Act — the deficit-cutting pact that ended the debt-ceiling standoff.
The White House's new budget projections show cumulative 2012-15 deficits will be $860 billion higher than its October 2011 estimates. That slippage, due partly to a weaker growth outlook, has already eroded about half the deal's $1.75 trillion in reduced (noninterest) spending over a decade.
A year ago, the White House projected that federal debt held by the public would equal 72.8% of GDP at the end of fiscal 2015. Now, it sees 78.4% debt-to-GDP.
The U.S. economy grew at a 1.5% annual rate in Q2 after a 1.9% pace in Q1. The White House has trimmed its growth forecasts, but still sees a 2.3% GDP rise for the full year and 2.7% in 2013.
Budget Savings In Doubt
Meanwhile, much of the budget deal's still-presumed savings are in doubt. A full $1 trillion in 10-year cuts would come via automatic spending caps due to take effect in January, saving $111 billion per year. Those cuts — half from the Pentagon — were intended as a poison pill that would force Republicans and Democrats to find common ground on alternative budget savings.
Defense Secretary Leon Panetta has warned that the across-the-board cuts "threaten the programs critical to our national security." Many senior Republican lawmakers agree, making it unlikely they will go into effect as scheduled.
Advocates on the left warn that the automatic cuts in nondefense programs will hurt the poor.
With all of these cuts inconveniently timed to take effect along with the fiscal cliff of unrelated tax hikes, CBO has warned of a recession from a sharp tightening of fiscal policy.
At the moment, it's far from clear how Washington will reach a consensus path averting the fiscal cliff, with much depending on election outcomes.
Bottom line: Factoring in the slippage in the past year and lack of clarity on much of the spending cuts agreed to last August, it seems that the fiscal dealmakers may be back at square one.
Can't All Get Along
Above all, S&P's decision last year to strip the U.S. of its AAA rating was a bet that U.S. political dysfunction would continue.
"The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed," S&P said at the time.
While economists agree that the debt-ceiling standoff created short-term economic uncertainty, S&P may have been unrealistic to expect House Republicans to give way on taxes after winning a sweeping victory in 2010.
Grand Bargain Next Year?
Higher-than-expected debt levels and warnings from ratings agencies will ramp up pressure on the parties to reach a grand bargain in the first half of 2013, although one influenced by electoral outcomes.
Moody's, Fitch and S&P all have a negative outlook on the U.S. credit rating. Moody's and Fitch still give the U.S. their highest rating, but Moody's said in May that a downgrade could come within a year without further deficit reduction.
Moody's expects 2.3% growth this year and 2.6% next year but warned that slower growth could weigh on its rating.
"Failure to reach agreement in 2013 on a credible deficit reduction plan and a worsening of the economic and fiscal outlook would likely result in a downgrade of the U.S. sovereign rating," Fitch said last November.

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