THE US DILEMMA – Please don’t drop the ball

By Mariska Krynauw

In November 2012 the American public will go to the polls to elect the next President for the United States of America. The race is between the current President Barack Obama, from the Democrats and Mitt Romney, from the Republicans.  Policy making is effectively on hold until after the elections. Making policy in the USA is going to remain difficult as the above parties don’t see eye to eye on most of the pressing issues.

After the elections, Congress has to deal with a series of tax and spending decisions that could bring about sharp fiscal tightening in 2013. Decisions on the federal government borrowing limits also need to be debated.  Republicans have critised President Obama’s healthcare reforms as they said it is too expensive.

In terms of who is going to win the elections, the race is very even. President Obama faces obstacles such as weak recovery of the economy and continued high unemployment.  Mr Romney’s has been critised as an extremely wealthy businessman with little connection with the average voter.

Policy Trends

As mentioned, significant fiscal decisions must be made after the election to avert a ‘fiscal cliff’ in 2013. The August 2011 deal to raise the debt ceiling imposed deficit-reducing measures that begin in 2012 and will amount to $ 2.1 trillion over the next decade. Tax cuts by George Bush and payroll reductions expires end of year and debt ceiling will have to be raised again.

The view is that tax cuts will only be for the lower and middle income groups and that rather welfare programmes and defence spending will be cut. It is further viewed that under the Romney administration the policy proposals will be much more conservative than in a second term of Obama.

Fiscal Policy

Fiscal policy has tightening and the federal budget deficit is expected to fall from 8.7% of GDP in 2011 to 7.6% in 2012, before dropping back to 3.3% by 2016.

There are no funding pressures as private sector is deleveraging. This means private sector pays back debt and banks etc. sit with a lot of cash to invest. The euro crisis and doubt about global recovery will keep rates low.

It seems likely that the tax burden will rise over the forecasted period, even if most of the fiscal consolidation will come through spending cuts. The tax distributions will depend on which party will win the elections.

Monetary Policy

Monetary policy is accommodative. The Federal Reserve is even prepared take further easing if economy continued to slow. The Fed has committed itself to keep interest rates low until 2014.

It also has engaged in a series of unorthodox monetary policy measures to support the economy, including the sale of its holdings of short-term Treasury Bills to switch proceeds into longer term maturities. By doing so the Fed tries to keep longer term rates as well. The most pressing dilemma is whether to intiate another round of quantitative easing (QE). The most recent bond buying (QE2) was done in mid-2011. The question is after more economic slowdown in second quarter if more QEs are needed. The answer is not straight forward. Inflation slowed to 1.4% and unemployment rate is still above 8%.

Analysts think that a smaller size of selling is possible towards the end of the year.

Economic growth

Economic growth slowed to 1.55 in first quarter of 2012. One reason for the low growth is the contractionary federal fiscal policies.

Private consumption is lower. In fact most indicators, such as employment, personal spending, consumer credit, retail sales and confidence – reflected a slowdown in second quarter of 2012. Although households are benefiting from low interest rates to refinance their mortgages, lower petrol prices to boost disposable income. The problem is that households still prefer to pay back debt and will be careful to go on a spending spree soon.


Economists, Politicians and decision makers differ on what is needed to trigger economic growth again.  This time it is different. Everybody had enjoyed the high economic growth as from 2002 until 2008. Most people thought this will just continue forever.  Asset prices were booming.  Budget surpluses were run by most Governments.  Households were accumulating more credit to spend even more.  Eventually reality kicked in, in 2008. Economic growth turned negative and the bubble burst.  The truth of the matter is that private households and companies are in such staged of shock that they are only prepared to pay back debt and not interested in any economic activities.

The USA policy makers tried all avenues.  Lowering the interest rates, QE 1 and 2, lower taxes, higher budget deficits, but it seems nothing works.  Until households are still into their deleveraging efforts, there is very little that could be done. The danger is that the Politicians in the USA are missing the point.  It is not the time to cut back on spending.  Interest rates are low and to increase spending will be cheap.  Until the private sector start spending or investing again, Government must fulfil that role.  This is done very successful in Japan.  To pay back debt is a long process.  Patient is now required and not irrational popular political decisions.

Concerns may be that between the Democrats and the Republicans the ball will be dropped and a second dip in economic growth could be closer than expected.

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