All eyes this week are on the Super Committee – the 12 members of Congress struggling to come up with a deal to reduce the Federal budget deficit by at least $1.2 trillion over the next 10 years. As the clock ticks down to the Wednesday deadline for their final proposal, hope for a last-minute deal is giving way to despair.
Failure, however, would not necessarily have immediate negative consequences. Automatic budget cuts – split between defense and nondefense spending – are supposed to kick in automatically if there is no deal. But they won’t actually take effect for some time. Nonetheless, some economists say that failure to reach a deal would further undermine the credit rating of the U.S.
To understand how this is all likely to play out between now and next year’s elections, it’s worthwhile examining the reasons that the Super Committee is blocked. They can’t succeed – and in fact, never had any hope of succeeding – for three very simple reasons:
The amount of money they are discussing is way too small. Last year’s Simpson-Bowles Commission, charged with finding ways to fix the deficit, proposed reductions of almost $4 trillion over 10 years, and would have liked more. Subsequently, a plan by a bipartisan group led by Pete Domenici and Alice Rivlin called for $6 trillion. The Senate’s so-called Gang of Six identified possible savings of between $3.7 trillion and $4.7 trillion. By contrast, the Super Committee is arguing over hundreds of billions. That’s simply not enough to put the U.S. economy on a sound footing.
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They disagree on what the fundamental problem is. A recent poll by a relatively centrist organization found that 33% of the public supports Occupy Wall Street, while 42% supports the Tea Party. Allowing for the possibility that a few incredibly angry people support both, there is nonetheless a supermajority who think that some group of Americans has profited over the past decade at the expense of everyone else in the country. But the public is divided on who these profiteers are and what to do about them. One group wants to slash government spending that goes to scroungers and special-interest groups, while the other wants to hike taxes on borderline-criminal, super-rich bankers. The major political parties aren’t really all that different: Republicans think the true problem is excessive government spending, while the Democrats think it is unreasonably low taxes on the rich.
There is no effective enforcement mechanism. In theory, failure by the Super Committee to agree on savings will trigger a list of painful automatic budget cuts. But Congress can change the terms of the trigger mechanism, accept some vague deficit-reduction guidelines, or subsequently restore any spending that has been eliminated. So in the end, the only cuts that get made and stay made will be those Congress is willing to live with.
When the deadline comes, the Super Committee may honestly acknowledge its failure, or it may craft some kind of “agreement in principle” that shifts the budget debate back to Congress. If the U.S. economy were a closed system, that would likely mean a continuation of the current weak recovery, with corporate profits improving but job creation too low to bring down unemployment.
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However, there are lots of problems in other parts of the world big enough to affect America. Europe presents two massive risks. The first is that the common euro currency comes apart, causing major banks around the world to suffer huge losses. The second is that banks hunker down to protect themselves against a default by countries in the Eurozone, and reduced bank lending helps push the global economy into recession.
Moreover, there is no shortage of risks beyond Europe. The overextended Chinese economy, with its own real estate bubble, is threatened by stagnation in the U.S. and Europe. And of course, the possibility of conflict over Iran’s potential nuclear capability could have economic effects that are unforeseeable.
There are certainly plenty of reasons to be defensive right now. But whatever the Super Committee proposes, Congress will have to slowly push the U.S. economy back toward a sustainable path. On the bright side, though, the stock market is actually up 2% over the past 12 months despite incredible day-to-day volatility. Stocks begin creeping upward whenever global turmoil abates.