Billions of dollars in automatic spending cuts are slated to kick in next week, and all eyes are on Washington as another round of partisan brinksmanship brings the country increasingly closer to economic disaster.
Or does it?
According to some experts, much of the fire and brimstone swirling around the $85 billion in spending cuts—called sequestration—is overblown and the impact of the cuts would be relatively concentrated.
"This year's federal budget is approximately $3.6 trillion and U.S. GDP is approximately $16 trillion, so the impact of $85 billion in cuts is minimal on a national level," according to a Friday report from financial services firm Keefe, Bruyette & Woods. "The impact will probably be greater in the Washington, D.C. suburbs since these areas are home to several agencies, including the Pentagon and defense contractors."
Bernard Baumohl, chief economist at The Economic Outlook Group agrees: "$85 billion is a trivial number considering the size of the U.S. economy."
Here are a few other reasons the sequester might not be the economic death sentence some are making it out to be:
The housing market is improving. As housing demand has increased, new home construction has taken off, with building permits surging to their highest level since 2008. That has fueled more economic activity in a sector that has traditionally helped pull the nation out of recession, and helped ease some of the tight inventory conditions around the nation. In addition to juicing new construction, heightened demand has also pushed home prices upward, a key component of net household worth.
"Price increases directly improve the net worth of households," says Greg Daco, economist at financial analytics firm IHS Global Insight, comparing it to the effect an improving stock market has. "As home prices rise, people feel richer," which ultimately translates into greater spending.
Consumer spending accounts for more than 70 percent of economic activity in the United States, so increased activity in that sector could give the broader economy a big boost. According to some estimates, for every $1-increase in household wealth, consumers spend 3 to 5 cents more.
"The potential increased spending more than offsets things like the payroll tax and sequestration cuts," Baumohl says.
Americans have seen this jig before. Despite all the fear-mongering about the impending disaster of deep spending cuts if Congress and the Obama administration can't reach some accord, these days Americans have a case of "brinksmanship fatigue," Baumohl says.
"Americans generally know how this is going to end," he adds. "Ultimately there's going to be some kind of agreement if not at the last minute, shortly thereafter."
Nevertheless, consumers remain wary about what's going on in Washington, and that could translate into some drag on economic activity, especially among those who aren't homeowners or stockholders.
"The lower income trenches of the population won't necessarily see any offset from those factors (property value increases and stock market performance)," Daco says. "It won't be a uniform type of effect."
The sequester (probably) won't last that long. How long the cuts stay in place remains a big question, but Baumohl doesn't expect the sequester to last through the remainder of the year. The more probable outcome is that cuts will remain for a month or so until some agreement is reached on spending and tax revenues in late March or early April.
Cuts for a period of three or four weeks would have "no measurable impact" on GDP growth, Baumohl says, but were the cuts to stay in place through the end of the year, the economy would grow 0.5 percent less, with GDP advancing 2.7 percent instead of 3.2 percent.
The more pressing concern for the economy is rising gas prices. The average retail price of gasoline surged to the highest level ever for this time of the year, to around $3.77 a gallon, bringing the nation closer to the "tipping point"—around $5 a gallon, according to Baumohl—when consumer spending will be hindered causing serious damage to the economy.
"Each dollar spent on gasoline reduces what's available for shopping and traveling," he says. "We're not [at $5 a gallon] yet but if prices continue to rise through winter and into spring, there is some concern."
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