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Having raised taxes and the debt ceiling, US Republicans have another test on public debt

As I have been predicting since the beginning of the year, I believe the Republicans will be able to force through some form of austerity before the budget battles in Washington are over this quarter. As the year began, we saw the fiscal cliff showdown end in a Republican defeat with taxes being raised. WHile the payroll tax hike was the biggest drag on growth, these tax increases were not likely enough in total to throw the US into recession.

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Afterwards, the timetable for the debt ceiling made it the most pressing issue. That was three weeks ago. My sense at the time was that the Republicans, having raised taxes, would be hard pressed to stick to the ideological views of their base of supporters and cut spending in one of the next rounds of fiscal negotiation in this quarter. The Republican party base mantra is lower taxes and lower spending. Having raised taxes, the Republicans in the house in particular would look foolish if they allowed the debt ceiling and sequestration to happen without extracting cuts. That’s why I see a government shutdown as likely and that’s why I am prediction recession in Q2.

The Republicans have already capitulated on the debt ceiling, understanding that they had no political leverage when default was the best alternative to a negotiated agreement. This is why I was predicting a week and a half ago that we should focus on sequestration. ANd indeed it does seem the Republicans are going to do so. Paul Ryan was quoted today on the Washington political morning shows saying cuts are coming:

The chairman of the House Budget Committee says Republicans will oppose tax increases and, as a result, deep, unpopular budget cuts will likely take effect.

Republican Rep. Paul Ryan of Wisconsin told NBC’s “Meet the Press” on Sunday that automatic spending cuts are scheduled to take hold because, quote, “Democrats have opposed our efforts to replace those cuts with others.”

Democrats have insisted taxes be part of the equation to dodge across-the-board spending cuts that are set to hit the Pentagon and many domestic programs. The spending cuts were set in motion in the hopes of spurring lawmakers to strike a large-scale deal to reduce the deficit.

Ryan was the 2012 vice presidential nominee. He says the country is heading toward a debt crisis if it doesn’t confront its spending.

The timetable here is automatic cuts starting on 1 March followed by a government shutdown unless an agreement is reached by 27 March. The government cuts have already begun with defense showing 46,000 job losses. I believe the shutdown will be enough to cause recession.

Remember, this is the last chance the Republicans have to get a win against the President on these issues. They have already capitualted twice. I do not believe they will do so a third time and so concessions from the Democrats in terms of cuts are coming or we will get a shutdown. If I am right, then it means recession, with all of the market and global implications that has. If I am wrong, the US should do pretty well in 2013 because the economy is in the midst of an upswing now being buoyed by employment gains and credit growth.

Sources: Bloomberg, The Hill

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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.