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Buying Time
The ceiling’s up and the stocks are down. Where will the American economy go from here?
by W.B. King
At extreme high speeds, a jetliner requires a full five miles to reverse course—an abrupt turn
would end in disaster.
The U.S. government has proven to be an even more complicated machine, as would-be political
pilots scrambled for control of the wheel over the course of many troubled weeks. In the end,
President Barack Obama and Republican House Majority Leader John Boehner came to
questionable terms. Their deal has left a stock market in decline, a marred credit rating, and
pensive politicians on both sides of the aisle. Now this massive jet – the American economy – is
entering the turn. The question remains: what is the destination?
“It’s a bad deal,” said Michael Linden, Director for Tax and Budget Policy at American
Progress. “And while it’s better than the alternative, which is default, it addresses deficit
reduction in all the wrong ways with no positive impact on job creation or job growth.”
Linden refers to the Budget Control Act of 2011, which was passed by the Senate in a vote of 74
to 26 and in the House of Representatives 269 to 161. The bill was designed to reduce the
nation’s $14.3 trillion deficit by at least $2.1 trillion over the next 10 years. After inking the deal,
President of Obama called it “an important first step to insuring that, as a nation, we live within
our means.”
Before Obama’s signature could dry, the Treasury got the green light to borrow an additional
$400 billion, with a future borrowing window still unlocked. Without these funds, a default
could have called for cutting roughly 40 percent of U.S. spending.
“The only thing this deal has set up is what we can’t do, and what we are unable to do as a
political culture, apparently, is reform social security, Medicare or taxes. And those are the only
three things that can be counted on for long term savings,” said Vin Weber, a managing partner
of Clark & Weinstock and republican party strategist who served in the House of Representatives
from 1981 to 1993. “I see this deal as mixed at best. I don’t see discretionary spending, whether
they are on the domestic side or the defense side, that can be realistically projected out for 10
years because every congress comes in with a new set of new mandates and a new sense of
reality.”
A Poor Standard Set?
Congress aside, there is a new sense of reality after Standards and Poor’s historically dropped the
U.S. credit rating from AAA to AA-plus, sending shock waves across the world. The stock
market lost roughly 635 points the Monday after the legislation passed. While signs of
improvement were realized in the days that followed, investors remain cautious.
“I am always somewhat reluctant to attribute one day’s move up or down in the market to any
specific event since markets are complex organisms with many unknowable elements. That said,
the Standards and Poor’s downgrade announced late Friday night would appear to be the
proximate trigger for Monday’s sharp sell-off in stocks,” said Gregg Fisher, president and chief
investment officer of the financial advisory firm Gerstein Fisher.
In some respects, the downgrade could be good news for smart investors, boosting the economy
in the long run. “A stock market correction actually reduces a long-term investor’s risk and raises
expected return,” said Fisher. “Unfortunately, in times of panic investors typically sell their
shares.” He added, “In our historical market research, we have noted that periods of negative
investor sentiment are very often attractive times to invest for long-term investors.”
Super Committee
The credit downgrade was a combination of economic indicators and a negative assessment of
government performance. The new legislation calls for the majority of big spending cuts to be
enacted in 2013, well after the 2012 election cycle. Kicking this can down the road was viewed
as win for Democrats, but Capitol Hill will eventually be forced to deal with this seemingly
never ending problem. On the chopping block are big-budget programs like Medicare, which
services over 100 million elderly and poor citizens each year.
“The deal did make cuts on discretionary spending, which is a useful step, but that doesn’t equate
to our long term fiscal imbalance. The unknown is what will happen in the second stage. We
have a super committee being set up, and they have a difficult task of reaching agreement on
spending cuts. It’s the big question that is out there: what this super committee can do or cannot
do,” said Alan Viard, former senior economist at the Federal Reserve Bank of Dallas and current
resident scholar at the American Enterprise Institute of Public Policy Research.
The 12-panel bipartisan super committee, appointed by colleagues (members were not
announced at press time), will be charged with the task of finding an additional $1.5 trillion in
cuts before Thanksgiving. Items on the table may include overhauling the exiting tax code and
entitlements.
“With regard to this super committee, I’m hopeful because I know many leaders of Congress and
have talked to all of them in both parties,” said Weber. “They are serious about the problem, but
this does not necessarily mean it will lead to a solution.”