In-depth analysis on Credit Writedowns Pro.

US economic headwinds mounting

As the New Year begins, there are four events that are creating significant headwinds for the US economy. There has been a lot of talk about the fiscal cliff in the press but behind this is the debate over the US debt ceiling, which will be breached by 31 December. In addition, there are two strikes that threaten to hurt the American economic infrastructure or raise prices to consumers.

Overall I am more positive about the US economy’s ability to continue to sustain this multi-year recovery on purely economic grounds than I was at the beginning of 2012. However politically the situation is dire, much worse than it was in 2012.

[private_gold]

First, there is the fiscal cliff, which is a crisis driven by the desire to cut the size of government more than the desire to cut deficits. Many of those now acting as deficit hawks were not hawks during the George W. Bush Administration and the Republican deficit position is conflicted by the desire to maintain or reduce tax rates. Clearly, this is about spending cuts and the size of government and political jockeying, not deficits then. My position here has always been that the fiscal cliff would not be avoided and that some measure of tax increases and spending cuts would create a fiscal drag in 2013. The question is whether a deal can be reached before the full fiscal drag of the cliff starts to bite and turns to recession. Since my baseline case is for recession, I believe this is a likely outcome.

Nevertheless, even were the United States able to do something about the fiscal cliff, the debt ceiling is another problem of huge importance. US Treasury Secretary Tim Geithner has warned that the United States will breach the debt ceiling and that he must turn to emergency measures to keep the United States from defaulting on its debt. If the US did default on its debt voluntarily as a result of a debt ceiling breach, it would be an economic Armageddon which would have wide-ranging economic consequences. The debt ceiling problem is as important as the fiscal cliff but it more vividly highlights the dysfunctionality of the US political system. 

Here’s how Bloomberg BusinessWeek explains the problem:

Treasury Secretary Timothy F. Geithner said he will take “extraordinary measures” to postpone a U.S. default into early 2013 while President Barack Obama and Congress work out a deficit-reduction deal.

Geithner, in a letter to congressional leaders today, said the government will hit its statutory debt ceiling on Dec. 31. To avert a default, the Treasury will take action to create about $200 billion in headroom under the debt limit, which would normally last about two months.

“However, given the significant uncertainty that now exists with regard to unresolved tax and spending policies for 2013, it is not possible to predict the effective duration of these measures,” Geithner said.

Geithner’s letter adds urgency to talks between Obama and congressional Republicans on a deficit-reduction plan. Obama has asked that raising the debt ceiling be part of that plan.

Obama and Congress both return to Washington tomorrow after an abbreviated Christmas holiday. They have five days before a deadline that would start to trigger more than $600 billion in tax increases and spending cuts that might cause a U.S. recession.

If that weren’t enough, there are tow major labour disputes in the US that threaten American ports and grain facilities. Andy Lees of AML Limited wrote about this:

The threat of imminent labour unrest was averted at 4 Pacific Northwest ports handling more than 25% of US grain exports and 50% of wheat exports. The dockworkers union will stay on the job despite “substandard” contract terms. The shipping companies declared a formal impasse in stalled contract talks with the international Longshore and Warehouse Union (ILWU) after 3000 members voted to reject the management offer. The companies said that the union had 3 choices, to accept management’s offer, to strike, or to continue working but seek further bargaining which is what is happening so far.  Meanwhile 15 container cargo ports on the Atlantic and Gulf coasts are bracing for a strike on December 30th by 15,000 union dockworkers unless shippers extend contracts. Obviously in the past, strikes by the dockworkers and longshore workers have had serious implications on US trade, and in the 1970’s on world grain prices.

I put less importance on these labour disputes but they are another headwind for the US economy that has been buoyed by a resurgent housing market and record low interest rates. Overall, it is the fiscal cliff and debt ceiling issues which will have the most meaningful impact if not resolved. Recession is guaranteed if no agreement is reached in the next couple of weeks. And if one is agreed to before then, recession is also still a possibility. Remember, this would be a self-inflicted politically-motivated economic wound for the US and it would have global implications.

P.S. – I have heard reports that the US holiday shopping season was the poorest since 2008. I am waiting for the data to confirm or deny this before I add this datapoint of weak consumer spending to the list of economic headwinds.

[/private_gold]

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.