Business Investment – first Casualty of the Fiscal Cliff

If you want to see what the effects of hitting the fiscal cliff might be in 2013, all you have to do is look at business fixed investment today. Over the previous 4 quarters, fixed investment averaged 4.5%; last quarter it was -2.1%.  What is the primary reason? The uncertainty caused by the failure of Congress to address the fiscal cliff.

Over the last several months the economy was picking up steam. Then Hurricane Sandy hit — now there is the fiscal cliff. The economy grew by 2.7% last quarter and the Congressional Budget Office projects the economy’s likely growth over next year at 3.0% – 3.5%.

Hitting the fiscal cliff will reduce spending by $607 billion. This is because Congress was unable to come up with a budget compromise 1.5 years ago during the debate over raising the debt ceiling. Therefore, they kicked the can down the road, thinking it would be easier now than then.

However, it is increasingly clear that Congressional Republicans and Democrats are instead playing a game of chicken over deficit negotiations. In this silly game, the side that gives in first or even puts a realistic proposal on the table will be blamed for everything that might go wrong in the economy.

Since neither side plans to yield in a way that will move the country forward and resolve the impasse, businesses have simply stopped investing. Furthermore, investment will remain dead in the water until Congress establishes the rules of the game under which they will operate in the future.

This Congressional stealth politics would have been alright had it not been for Hurricane Sandy. However, the destructive hurricane not only ripped through the Northeast, but the after effects are now rippling through the economy.

Before Hurricane Sandy, the economy had significant forward momentum. Housing starts were up significantly, home prices increased nationally, new home sales were up, and so were automobile sales, consumer confidence and retail spending.

Close to 600,000 workers came back into the labor force in October because they were optimistic about finding employment. However, the latest report on new claims for unemployment insurance (a measure of the number of persons laid off) showed a significant increase from 366,000 in October to 393,000 in November. Additionally, the Purchasing Managers Index also declined noticeably from 51.7 in October to 49.5 in November.

If Congress fails to compromise on the debt issue, and we hit the fiscal cliff, GDP growth will stall to less than 1% in 2013. Ironically, we don’t have to wait until then to see the effects. What is now happening to business fixed investment is a preview of what we can expect in the future. It is not a pretty picture.