Washington's brash sequestration stunt

The impact of automatic spending cuts on US GDP is being exaggerated. But the rating agencies will respond if Washington keeps up its legislative daredevil act.

The panic surrounding the billions of dollars in mandatory spending cuts that US President Barack Obama had to swallow overnight is terribly overblown. But the ‘sequestration’ is part of a broader pattern of behaviour from Washington that could very easily bring about another credit rating downgrade for the United States.

Eighty-five billion US dollars in compulsory spending cuts, split evenly between defence and non-defence spending, is now active.

The thing is, that headline number is wrong. That number comes from the specific legislative term "budget authority”, which means the government no longer has the right to spend that $US85 billion ($A83.39 billion). Whether it was going to spend all of it for sure is impossible to tell.
Economists and journalists took that figure and concluded that over 0.5 per cent of US GDP had been erased, just as the recovery is taking hold.
A late release from the non-partisan Congressional Budget Office, which has been largely ignored, shows the actual spending reduction in net terms will more likely be something like $US44 billion.

"Discretionary outlays will drop by $35 billion and mandatory spending will be reduced by $9 billion this year as a direct result of those procedures [sequestration]; additional reductions in outlays attributable to the cuts in 2013 funding will occur in later years," the report says.
That’s barely half the headline rate and amounts to just 0.25 per cent of GDP. The CBO’s warnings about the speed of fiscal contraction, faster than any post-war period, have also been largely overlooked.
This is certainly not a good development by any measure. The US recovery will be weakened and some government services will be disrupted by this unfathomably stupid method of federal governance. But this episode is not as bad as it looks.
The sequestration is the postscript to the compromise reached by the Democrats and Republicans to avert the New Year’s fiscal cliff, which Obama signed on January 3.
That deal was considered a huge victory for Obama, because he managed to secure from the Republicans a tax hike to 39.6 per cent from 35 per cent on ordinary incomes above $400,000 and 23.8 per cent from 15 per cent on investment income.
The last congressional Republican to vote for an income tax hike was New Mexico Senator Pietro ‘Pete’ Domenici. That was 22 years ago, when President George H W Bush still had two years left in office.
Now, Republican Speaker of the House John Boehner has refused to even engage the president to sidestep this deadline because his party simply won’t tolerate more tax hikes. Eighty-five billion dollars in spending cuts without a tax hike – even though it’s not really that much – is considered a win for Boehner.
But you could tell that the story was inflated when a few headlines popped up pointing to a meaningful shift within the Republican Party against its defence spending dogma.
The Harry S Truman aircraft carrier is currently sitting at the Norfolk Naval Station on the eastern coast of Virginia. It was supposed to depart for the Gulf on February 8, but the Department of Defense kept the vessel moored in anticipation of not just last night’s events, but another looming fiscal battle.
While the Republicans have determined that they’ll allow a little disruption to the military – and that was a pre-emptive move by the Department of Defense by the way – if it means standing firm against tax increases, the idea that they’re looking to seriously cut the military budget, or even its rate of growth, is fantasy.
The US defence budget, which is famously more than the next 17 largest military spenders combined, is the sacred political cow of the Republicans. The Democrats have Social Security and Medicare/Medicaid.
Medicare providers like hospitals and doctors are up for a two per cent cut from the sequestration; and they aren’t complaining. It’s minuscule and they know this is bluff.
Aside from that, America’s three biggest spending departments that make up 82 per cent of what Washington dishes out, have been left untouched by the sequestration.
Speaking of medical care, a lot of metaphors have been thrown around to describe last night’s events. Putting modesty aside, I think I’ve got one of the better ones for you.
It’s akin to going to the doctor for a check-up on your weight loss campaign. You were once seriously obese, for a long time. You’re still carrying some extra pounds, but you’re exercising like a champion and the weight is coming off, fast.
Too fast actually, warns the doctor. If you lose fat too quickly you can do muscle damage, experience gallbladder problems and – listen up guys – you can even lose your hair, quite rapidly.
Your physician encourages you to keep exercising, but perhaps less ambitiously, and to start focusing on some of the other factors that led to your weight gain. Diet would be a good start.
With this news, you continue your weight loss mission by chopping off one of your fingers. It doesn’t address the underlying problem, it weighed bugger all and…ouch! That thing was kind of useful.
The sequestration is damaging, but it doesn’t address America’s real spending problems and typifies the flaw in Washington’s methods.
The practice of both political parties to use legislative deadlines as an arena to play chicken over their debt reduction plans, rather than talking and compromising, is ruining the confidence that its citizens and international investors have in Washington’s ability to solve the problem without screwing up everything else.
And there are more legislative deadlines to come. On March 27, the continuing resolution to fund the federal government – which is code for when the US, officially speaking, doesn’t have a budget – expires and there’s the potential for a government shutdown and another political showdown.
Less than two months later the debt ceiling is due to be reached, which contains all the elements of the sequestration game. This has Fitch Rating’s particularly concerned.
"We don’t think another debt ceiling crisis like we had in August 2011 would be consistent with the US retaining its AAA rating,” Fitch managing director of sovereign ratings David Riley said on Bloomberg TV.
Excuse me, doctor. Can you sew my finger back on?
Alexander Liddington-Cox is Business Spectator’s North America Correspondent.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles