US: Recovery vs debt ceiling battle

The US economic recovery continues to gather pace and this should be accompanied by improving jobs growth and rising interest rates through 2011, but this recovery could be knocked by political gridlock, economist Robert Wescott warns.

Wescott believes analysts are probably underestimating the potential for a sharp setback in global financial markets if the Congressional debate on a timely increase in the legislative ceiling on US federal debt descends into gridlock this spring.

“I think the consensus view is that there is perhaps a 1% chance of a political meltdown, with a government shutdown and potential disruptions to US bond auctions. I don’t think this is high probability, but I do think the risk is much higher than markets and analysts currently anticipate.”

The $14.3tn debt ceiling is on course to be breached sometime between the end of March and mid May on current trends, and Republicans are likely to press for steep future cuts in government spending in return for supporting any debt ceiling expansion.

Wescott said that financial markets are fickle, and with the US’ unsustainably high debt burden, it might not take much, if the debt ceiling discussions turn acrimonious, to spark fears of a debt default and undermine the confidence of investors around the world.

He added: “If there was a loss of confidence, it could quickly ripple through all financial markets from equities to bonds to currencies to commodity prices.”

Wescott pointed to several key factors indicating that US jobs growth is likely to accelerate over the course of 2011:

   – U.S. initial claims for unemployment insurance have now fallen rather steadily in the last four months, suggesting that labour markets are firming.
   – The latest Business Roundtable CEO Economic Outlook Survey of top executives from leading US companies, showed a record high percentage of CEOs planning increases in their hiring over the next six months.
   – Surveys of US small businesses indicate plans to increase hiring in 2011 –  the first rise in three years.

Robert Wescott concluded, “Big budget deficits eventually crowd out private investment by putting upward pressure on interest rates and also increase the risks of inflation. If a country doesn’t have economic growth, then it becomes extremely difficult to deal with a debt problem. The US now has an opportunity to come to grips with its fiscal deficit as the economy gains momentum, but it will require strong political leadership.”

 

Robert Wescott served as Special Assistant to the President for Economic Policy in the Clinton White House from 1999 to 2001 and testified as an expert witness before a US Congressional Committee on the causes of the post-Lehman financial crisis in late 2008. Wescott was appointed a member of the Pioneer Investments Global Asset Allocation Advisory Board in January 2010.

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