US Fiscal Drag is World's Problem—Cliff or No Cliff
Austerity has already hit home in the U.S., and is putting global growth prospects in jeopardy.
I. The rest of the world is still heavily reliant on U.S. growth
For all the importance of emerging markets, global growth is still hostage to America’s own growth prospects. Per Citi Research, each one percentage-point contraction in U.S. growth on average cuts 0.2 to 0.3 percentage points off global growth. In other words, “a given decline in U.S. growth reduces the pace of expansion in other countries on average by roughly 20 to 30 percent of the U.S. decline.”
A hit at any time, but a particular blow when other regions aren’t able to pick up the slack.
II. The U.S. economy is flirting with “stall speed”
Risks are mounting as America’s economy has failed to pick up speed in this expansion. Real GDP on average has grown by just 2.2 percent annualized since the recession officially ended in mid-2009. The pace has consistently slowed over that period; growth averaged 2.7 percent in the second half of 2009, less than 2.4 percent in 2010, just 2percent last year and 1.85 percent in the first half of 2012. This leaves the nation dangerously close to “stall speed,” defined by Citi as when growth on a rolling four-quarter basis has fallen below 1.5 percent. In such cases, (a) recession has typically ensued, and (b) growth has subsequently fallen by nearly three percentage points on average.
III. The fiscal “drag” is a key culprit
There are four main inputs to GDP: Consumption, Investment, Net Exports, and Government Spending. Even ahead of the fiscal tightening due to kick in on Jan. 1, 2013 (such as automatic defense cuts agreed to as part of the negotiation to raise the debt ceiling last year), government spending has been shrinking. In fact, government spending has shrunk each quarter now for two straight years, subtracting 0.3 percentage-points from GDP on average since mid-2009. There are two components of this category: (a) federal spending, which has declined in six of the past seven quarters, and (b) state and local government spending, which has actually been shrinking for eleven straight quarters now, or nearly three years.
IV. Cliff or no cliff, further slippage is likely
Absent some sort of agreement in Washington, the full brunt of the fiscal tightening due to kick in at the start of next year could, by some estimates, equal a 5-percentage-point hit to GDP in the first quarter. Even if an agreement to offset some or all of that impact is reached, it’s highly unlikely that Washington — particularly one marked by a Republican-led Senate, as most polling indicates — will come to any bargain that includes a significant boost to government spending now or anytime in the near future. Indeed, the focus of campaign rhetoric on both sides still remains largely on where and how deep cuts to government spending going forward will be.
V. Time is running out for a Fed-fueled pick-up
Ben Bernanke to the rescue? The Federal Reserve, aware of this fiscal drag, has stepped up with an aggressive stimulus plan intended to spur a private-sector pickup, or at the very least to cushion the impact of continued government cutbacks. But even its “unlimited” asset purchases will test the limits of monetary stimulus when it comes to boosting growth. Under the current plan, asset purchases totaling $40 billion a month are equal to an injection of roughly $480 billion a year — or 0.03 percent of America’s $15.6 trillion economy. One-hundredth the size, that is, of the fiscal drag.
Obviously, the Fed is counting on financial markets to leverage its spending into much larger increases in asset prices and, more broadly, to spur confidence, hiring and investment. Still, its task is a formidable one. It isn’t just government spending that is on the wane in America; exports are under threat as well as major trading partners from Europe to China themselves are slowing. Consumption and investment will have to do increasingly heavy lifting at a time when unemployment remains high and companies remain reluctant to spend. For now, their footing — and by extension, the position of the global economy — is wobbly.
- by CNBC's Kelly Evans
Follow Kelly Evans on Twitter: twitter.com/Kelly_Evans
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