Talk to economists and people who work in the financial markets these days and what you’ll hear is reminiscent of the ominous warnings that you occasionally hear from pilots about strong weather fronts. We’re facing not one wave of turbulence, but several.
First, there’s Europe and the eurozone. It’s possible that the situation could be worse in Greece, but not that much worse. There’s a pretty good chance that country will be exiting the eurozone soon, but either way, Greece is putting enormous stress on its economy. Then there’s Spain, which has an economy larger than Greece, also in trouble. With Europe teetering on the edge of recession, there are limits to how much even Germany can do to keep the eurozone—now the world’s largest single economy—from going into a serious tailspin. Europe contributes 21 percent of global economic growth, so there is rather obvious significance for the U.S.
Then, there is China, whose economy is slowing. Acknowledging the problem, the Chinese government just announced that it was placing greater emphasis on economic growth. Its central bank is expected to lower rates soon. It’s unlikely that China will go into a recession, but don’t expect purchases of U.S. goods there to match those of the last few years.
But it’s the fragile nature of America’s own economy—and questions about whether our political process is capable of coping with immediate and simultaneous challenges—that make things so much worse. The Federal Reserve Board has acted heroically to pump up the economy. As the International Strategy and Investment Group reports, the Fed’s efforts put the trade-weighted dollar at close to a record low, making it almost as competitive as it ever has been. But a weak world economy still limits the U.S. advantage to sell.
The term “fiscal cliff” has been rapidly entering the economic lexicon. People using the phrase may not know exactly what is scheduled to happen at the end of this year. Probably more than anything else, though, they may know that the George W. Bush-era income-tax cuts will be eliminated both for earners above and below the $250,000 level if not renewed by Dec. 31. They also may know that some significant spending cuts will automatically be made, unless Congress takes action, that will cut defense and nondefense funding pretty much evenly. Of course, Social Security, Medicare, and Medicaid, the real drivers in the increase of federal spending, are exempted from those cuts.
A few may even know that the capital gains tax rates will go up unless Congress acts. According to ISI Group, the top rate on dividends would almost triple, going from 15 percent to 43.4 percent. Andy Laperriere, who heads up the ISI shop, said understatedly in a report to his clients, “We find investors to be interested in the many facets of the fiscal cliff, but we don’t believe investors have repositioned their portfolios yet. We suspect that will change late this summer and into the fall as investors begin to focus on the outlook for next year.”
Call me simple, but I think that means that people will start dumping their stocks.
The danger, of course, is another stalemate over taxes and spending, but bigger this time. Policy moves that collectively could take an estimated 3.5 percentage-point bite out of the U.S. Gross Domestic Product are scheduled to kick in at the start of next year, hitting a very fragile economy. And let’s not forget the threat of another debt-ceiling showdown. We have the ingredients for enough economic uncertainty that it would be bizarre if many large companies and financial institutions didn’t freeze hiring, expansion, investing, borrowing, and lending. Individual investors would also probably head for the exits.
It’s not hard to see how a slowing economy and tanking market could hurt President Obama’s reelection bid. But were I a Republican, I’d worry that if things hit the fan, I might be held culpable, too. House Speaker John Boehner’s recently stated position, basically saying, This is really important, we can’t kick the can down the sidewalk again, we need to do something immediately—and, oh, by the way, we aren’t going to compromise a bit on the issue of additional taxes, can’t pass the straight-face test.
If Obama is talking “balance” and Republicans are seen as sticking to their “no-compromise” position, this could get interesting. The sight last August of the eight GOP presidential candidates each rejecting a hypothetical 10-to-1 deal (passing on $10 in spending cuts for each dollar in tax increases) could end up as a very interesting television ad before this is over with. Republicans may have to worry about more than their base.
Given the anger toward Washington and increasing cynicism, we could see some very serious lashing out this November—and not just at people wearing any one particular color of jerseys.
This article appears in the May 22, 2012, edition of National Journal Daily.