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The sequester will happen

My thesis these past few years is that a fiscal retrenchment to reduce deficits in the US was likely to lead to a shortened business cycle. I have been saying since 2013 began that politics favoured the United States going into austerity mode this year because deficit hawks have finally been able to galvanize support for their framing of the fiscal debate. Increasingly, this appears to be an accurate view.

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Business Insider’s Joe Weisenthal’s contacts in Washington and media reports are all suggesting that the sequestration is going to happen as planned. My logic for why this will occur is simple: “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 [have been saying] that we should focus on sequestration… 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. “

The Republican base is in favour of lower taxes and lower spending. It doesn’t sit well with that base that taxes and spending are going higher – with Republican support. Republican members of the US House of Representatives are particularly under pressure to show deficit hawk bona fides because they must face voters every two years. If they allow the President and his party to pass the fiscal cliff with tax increases, the debt ceiling with no strings attached and the sequestration without any budget cuts, they will not have an easy go of it in Republican primaries or in the mid-term general elections. I believe this pressure to produce some tangible proof that they have either lowered taxes or spending or both is immense and is working in favour of the sequestration moving forward as planned.

Now, Republicans do support a strong US military and are loath to cut spending there. The reason the fiscal cliff deal in 2011 had draconian military cuts was to make the sequestration unpalatable for Republicans. But the Republicans have been backed into a rhetorical corner and are now prepared to make these cuts. The military newspaper Stars and Stripes explains:

Congressional leaders appear to have reach consensus that it is safer politically to allow deep and arbitrary cuts to military budgets than it is to negotiate a large debt-reduction deal that would have names attached.

With Republicans and Democrats unwilling to make difficult decisions to address budget deficits in a balanced way, the military is being forced to cut training, cancel construction projects, defer maintenance of ships, aircraft and vehicles, cancel professional conferences, halt most temporary duty assignments, and interrupt supply and equipment purchases.
Quality of life for the military also is being impacted as dependents lose jobs, local economies and businesses lose contracts, and base operations, including family support programs, take immediate budget cuts.

The entire Department of Defense has imposed a civilian-hiring freeze. At least 46,000 temporary employees are getting pink slips and many more employees under “term” contracts won’t see those contracts renewed.

Politico thinks that the sequester will happen temporarily but that a deal might result soon afterwards:

SEQUESTER STATUS: STILL HAPPENING — Consensus among insiders remains that the sequester cuts will hit, at least temporarily, but could get modified or changed in a deal later in March that wraps in the continuing resolution funding the government. But there is still little clarity on exactly what Republicans will push for in terms of spending cuts in any final deal or what precisely they will use as leverage. Whatever the case, weeks of posturing remain and nothing will get done until the last possible moment.

President Obama is out talking about closing the deficit gap through added revenue. That has to mean taxes. And that is 180 degrees away from the Republican position of lower taxes and less spending. This is what has set this duel up and I don’t see it getting resolved without cuts because a resolution without cuts means complete capitulation by the House Republicans and a serious political defeat for their party.

To be continued.

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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.