The US government had almost run out of money but Congress started delivering appropriations on the FY 2012 budget last week, avoiding a shut-down until mid-December. More importantly, the bipartisan Joint Select Committee is supposed to deliver a proposal for fiscal measures worth at least USD 1.2 tr in ten-year terms, thus setting the stage for a final compromise in the Committee on November 23 and for a Congressional up-or-down vote one month later. Otherwise, spending cuts evenly split between defence and discretionary social spending to achieve the reductions will have to be made by the OMB starting January 1, 2013. As of Friday morning, the super-committee had essentially settled nothing and, on a most positive account, put together some USD 750-850 bn in potential ten-year fiscal adjustment measures, or a good half a point of GDP per annum!

The Democrats seem ready to tackle some mandatory spending programmes in exchange for significant Republican concessions on raising tax revenue which have not come about so far. Effectively constrained by the Grover Norquist-monitored pledge (“no revenue increases”), the GOP fails to allow for sufficient ownership of fiscal adjustment proposals by both parties, risking deadlock in the Committee and in Congress later on. With Congressional leadership and the White House pretty detached from talks, the risk of failure is imminent. However, Congress should be interested in reining in longterm spending and raising revenue despite deep ideological obstacles and the upcoming 2012 elections. Adjustments of USD 3-4 tr over ten years are needed. It would send strongly negative signals to the markets if Congress cannot agree on USD 1.2 tr. Only if markets were to assume that the GOP wins the Senate, the House and the White House on November 4, 2012, and that Republican-style adjustments were to ensue, could bond markets stay calm – many big ifs. “Help” will come from Europe, whose crisis will drive home to Washington, DC the horrors of bond markets shutting down. It is a long time until December 23.

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Copyright © 2011 • Deutsche Bank AG, DB Research

Deutsche Bank Research is responsible for macroeconomic analysis within Deutsche Bank Group and acts as consultant for the bank, its clients and stakeholders. We analyse relevant trends for the bank in financial markets, the economy and society and highlight risks and opportunities. DB Research delivers high-quality, independent analysis and actively promotes public debate on economic, fiscal, labour market and social policy issues.

Published by kind permission of Thomas Mayer.