This post will discuss the self-induced austerity measures U.S. politicians have manufactured, a major hurdle to the recovery in the world’s largest economy.
The U.S. economy is headed in the right direction thanks to stronger consumer confidence, and now the Federal Reserve is signaling that its policymakers feel that it may be soon to begin the process of draining liquidity from the financial system. But this could not come at a worse time. U.S. politicians remain dramatically partisan and refuse to cooperate on nearly anything; voting among party lines for every major vote in recent memory, seemingly if only to spite one another.
The best manifestation of this division is best exemplified by the budget negotiations, which have pitted Democrats, in control of the White House and the upper legislative house (the Senate), against the Republicans, in control of the House of Representatives (the lower legislative house). The first such impacts of these cuts were seen in the 4Q’12, when the U.S. economy contracted by -0.1% annually. Why?
The swift -22.0% annualized cut in defense spending, the sharpest pace in a decade, alongside weak inventory growth and the trade deficit (when imports outpace exports), created a -2.7% annualized drag on the U.S. economy. This drag was just enough to offset the strong combined +2.6% annualized growth rate in consumption and private investment (further highlighting how much stronger the U.S. consumer is). This weak growth is noted on the graph above on the far right, where the 4Q’12 GDP figure is circled, with the notation “austerity,” the term meaning “a fiscal policy that entails reduced government spending and higher tax rates, with the purpose of eliminating a budget deficit.” Clearly, a further reduction in government spending – part of that -2.7% drag, best reflected by the steep drop in defense spending – is going to weigh on growth.
As the headlines surrounding the budget sequestration, as it is officially called, continue to flow. In total, $109B in cuts will be made over the course of 2013; however, this results in $85B in cuts on March 1 alone. This will be the beginning of $1.2T (T for trillion) in budget cuts from 2013 through 2021, unless new measures can be agreed upon.
If politicians do not address the budget sequestration right away, then any prolonged period of drain on the economy could negatively affect the U.S. Dollar. While any increased credit risk is likely to roil global markets just as it did in 2011, culminating in Standard & Poor’s downgrading the United States’ then-pristine rating from ‘AAA’ to ‘AA+,’ the weaker economy could alter the Federal Reserve’s exit plans. If it becomes clear that the Fed will have to reverse its recent rhetoric in order to keep liquidity provisions in place, recent gains seen by the U.S. Dollar could be unwound, as the economy suffers. While the U.S. Dollar is strong now and enjoys a potentially bright future, there are certainly concerns lingering; political division in the United States could be the straw that breaks the U.S. economy’s and the U.S. Dollar’s back in the 2H’13.
This series of eight posts will focus on the major themes affecting currency markets. The fifth post in this series will discuss the recently berated British Pound and why the world’s oldest currency looks, well, old.