America gears up for crisis, again

The sequester will hit in March, and depress GDP.

Photograph: Getty Images

Meet the new US politico-economic crisis, same as the old US politico-economic crisis. The country didn't throw itself off the fiscal cliff, it "suspended" the debt ceiling (though that's going to come back to haunt it at the end of March), and now it's facing the "sequester".

These are the automatic spending cuts agreed in the last debt ceiling fight, in the summer of 2011, and repeatedly postponed until now. They total $1.2trn, and are currently set to come into force in March. The cuts will hit the primarily hit defence budget, domestic programs, and federal funding to states. A chart from Pew highlights how much the states' budgets will be reduced, with multiple programs, including education, being cut by 100%:

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Pew adds (pdf):

Because most states are not permitted to run a deficit, states either would have to replace the loss in federal revenues with state funds or implement budget cuts.

For a preview of the effect of the sequester, take a look at the last quarter of US growth. A quirk of defence budgets meant that military spending fell by 22 per cent, as the typically periodic spending combined with the shrinking US involvement in overseas operations to reduce expenditures by over $40bn. That nearly single-handedly resulted in a contraction as opposed to the 1.1 per cent growth predicted.

(It's worth noting that that's not necessarily a bad thing, of course. If you think the military-industrial complex has a pernicious effect on American life, then it's worth shrinking its influence, even if that's at the cost of a temporary blow to GDP)

The Congressional Budget Office — America's version of our ONS — has a set of forecasts which takes into account the effect of the sequester, and it's not pretty:

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The Atlantic's Jordan Weissmann explains:

Remember how nobody wanted the Bush tax cuts to expire, but CBO had to assume the expiration because it was in the law? Well, nobody wants to gouge the defense budget and domestic programs this year, but because the CBO isn't assume that Congress will revise the cuts. So these figures assume the country swallows that massive dose of austerity in the spring.

And as it turns out, even in that nightmare scenario, the CBO doesn't see the economy getting much worse than it is today. The sequestration cuts wouldn't plunge us into a new depression just prolong the one we've been in.

These four charts essentially capture what the CBO sees ahead for us should the sequester snap into effect. Real gross domestic product growth would fall to about 1.4 percent his year, from 1.9 last year. But then it would bounce back to 3.4 percent in 2014. Likewise, unemployment would edge back up to around 8 percent this year before resuming its decline. At that point we would still be years away from from seeing even 6 percent unemployment.

The effect of the sequester on the US deficit and debt-to-GDP ratio is, at least, positive. For the first time in recent history, the 2013 deficit is officially predicted to be under a trillion dollars, and the debt-to-GDP ratio is likely to sit comfortably at 80 per cent for the foreseeable future. But really, the deficit isn't what matters — it's growth. And if the sequester comes in, US GDP isn't expected to return to pre-crisis trend levels until 2017.

Some of these cuts will still come in. Even the Democrats want to "tackle the deficit" to a certain extent, and much of the negotiation will be around where the cuts should come from, rather than whether they should happen at all. But hopefully it won't be quite as damaging as it could be.