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The Debt Ceiling Extension Is Bad News for the Economy

Will the Washington budget battles ever end?

In Washington, members of Congress are congratulating themselves for coming up with the idea of extending the government's ability to borrow money for three months, which means the much ballyhooed risk of a U.S. government default won't arise in February after all. The House of Representatives has passed a measure that will extend that deadline until mid May. The Senate says it will pass the measure, and President Barack Obama says he'll sign it.

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Woohoo. We should be stoked, I guess. Except that the temporary tactical measures that have replaced responsible governing are dragging down the economy and delaying the return of prosperity. Dithering in Washington means budget battles will probably dominate the whole legislative agenda in 2013, preventing politicians from moving on to other things that might actually help the economy.

The idea behind the three-month debt ceiling extension is that Congress will have a chance to deal with two other critical matters before they have to approve a longer-term hike in Washington's borrowing limit. The first is the so-called sequester, which is $110 billion in spending cuts due to go into effect March 1. This has become kind of a rolling deadline that never quite occurs, creating a mirage meant to make it seem like Congress is getting serious about cutting spending.

The whole sequester plan surfaced in the summer of 2011 and was meant to be a loaded gun that would force a congressional "supercommittee" to come up with more rational ways to cut spending. The supercommittee failed, naturally, triggering the sequester, originally due to go into effect January 1, 2013. That got delayed until March 1, as part of the fiscal-cliff deal. It could get delayed again and again, the legislative equivalent of Jarndyce v. Jarndyce. But Congressional leaders insist that this time they're serious and they won't let the sequester deadline lapse any more.

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Another deadline looms on March 27, when the legislation funding the federal government will expire. That means non-essential functions will shut down, a al Newt Gingrich circa 1995 and 1996. Congress could simply appropriate new funds to keep the government operating, but Republicans leaders aren't sure they'll go along with that. Better to bring down the house, to make their point about excessive spending.

All of these threats and maneuvers take an economic toll. Economists estimate that the tax hikes that went into effect at the start of the year as part of the first fiscal-cliff deal will lop about one percentage point off GDP growth in 2013. Forecasting firm Macroeconomic Advisers says the mere possibility of hitting the debt ceiling in 2013--whether that event is delayed or not--could cut another half point off GDP growth, mainly because the uncertainty it causes would curtail spending along with demand for risky assets such as stocks. Actually hitting the debt ceiling and entering a default scenario would be far, far worse.

If the full sequester goes into effect, that would cut GDP growth by another three-quarters of a percentage point, according to Macroeconomic Advisers. And a government shutdown would cost the economy a quarter point of GDP growth for every week it was in effect.

Add it all up, and wrangling over the budget could cost the economy at least 2.5 percentage points of growth in 2013, with some of that already occurring. It's no exaggeration to say thousands of Americans won't find work this year because of dickering in Washington.

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At the moment, the economy is growing at an annual rate of less than two percent. That's pretty weak. If a few things go wrong in Washington, growth will turn negative and we'll be in another recession. CEOs are usually pretty good at math, and their awareness of this fragility will keep hiring and business spending at a minimum until Washington no longer poses such a threat to the economy.

Politicians seem to think that as long as they reach some kind of last-minute deal on budget matters, all is well. But all is not well. Political brinkmanship has badly damaged America's reputation, making it a less appealing place to do business. That's a major reason the nation's competitiveness ranking, as measured by the World Economic Forum, has fallen from first in 2008 to seventh in 2012. It's also one of the principal reasons Standard & Poor's downgraded America's credit rating in 2011, and Moody's and Fitch may downgrade it soon as well.

Is delaying a man-made crisis better than just facing up to it and making a decision? Today it may seem so. Tomorrow it probably won't.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success. Follow him on Twitter: @rickjnewman.

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