America's very own Greek crisis

As America's fiscal cliff looms large, another round of quantitative easing seems inevitable, but with spending cutbacks scheduled and business investment projects being cancelled, a US depression is still a possibility.

As stock markets gain solace from avoiding a major European crisis, attention is going to switch to the US. The markets are expecting another quantitative easing to give share, bond and commodity speculation a big boost. But money printing QE3 style will have a marginal affect on the real US economy.

My guess (and its a guess) is that the US will bring on QE3 because of the power of Wall Street. But this week my old friend, the veteran US economist Al Wojnilower, sent me an email warning me of what was ahead in the US further down the track. Let me share with you parts of the Wojnilower warning of a minor version of the Greek crisis looming in the US.

Wojnilower points out that for years, Congress kept on raising spending and lowering taxes, while enacting "austerity” measures to take effect in the future. Now the future (the "fiscal cliff”) is here, and it just happens to coincide with a Presidential election.

Laws scheduled to take effect at year end will raise taxes and lower federal spending by over 4 per cent of GDP in 2013. Since the growth trend of GDP is probably 3 per cent at best, this implies the return of recession in 2013 unless legislation is passed in a timely fashion. Worse still , the Treasury debt ceiling will be reached early next year. If political gridlock results in prolonged failure to raise the ceiling, paralysing the national government, the recession could turn into a depression.

Few people fathom the pivotal role that government plays in US economic life. Of a US adult population of some 244 million, close to half receive significant parts of their income directly from government. The largest chunk is 54 million social security recipients, but here are also civil servants and armed forces members, recipients of food stamps, farm subsidies, unemployment insurance, and so on. Add to these the employees of the defence plus contractors in construction, and other industries whose income comes from government contracts.

Sizable spending cutbacks, military as well as civilian, are already occurring (mainly explaining the sluggishness in the economy), and much larger ones are scheduled. While the political consequences are debatable, adverse repercussions on the business and employment climate are virtually certain.

It is reasonable for forecasters to presume that pending fiscal restraints will be modified and the debt ceiling lifted without disruptive confrontation, thereby allowing GDP to rise about 2 per cent in 2013. But prudent decision makers cannot and should not take this for granted. Major business investment projects are being postponed or cancelled, subtracting from business activity now and increasingly so as time passes. Although no model can quantify the negative impact, no investor can ignore it.



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