Most of us have seen the movie “Jaws” and are familiar with the suspense created by the hunters chasing the shark or the shark hunting the hunters.  The suspense is interrupted by the periodic return of the shark and attempts to sink the boat or kill the shark.  Our recent experience with the summer thriller involving the debt ceiling will return in the coming months to scare the electorate and investors alike.

On August 2, Congress passed the increase of $900 billion in the debt ceiling and agreed to the outline of spending cuts of $917 billion.  The increase in the debt ceiling will not be enough to see us through the 2012 elections. After the summer recess, Congress will return around Labor Day to work on the federal budget for the fiscal year beginning October 1.  Do you recall last year’s budget fight that was finally resolved in late April?  This year’s budget debate promises to be as contentious as last year’s.  The debate promises to continue arguments over spending cuts and possibly add real debate on revenue increases.

As the budget scene dissolves, the lights will come up for the report of the special select bipartisan committee required by the August 2nd legislation to address further spending cuts.  This committee is to report before November 23 recommendations for an additional $1.5 trillion of spending cuts in order to raise the debt ceiling again.  If this committee cannot come up with at least $1.2 trillion in cuts, Treasury would only get $1.2 trillion of additional borrowing authority and automatic cuts of the same amount would be made to the defense budget and payments to Medicare providers. These spending cuts need to be enacted by Congress prior to December 23 to avoid the automatic cuts.  The increase in borrowing authority may not see the government through 2012, so the debate might need to be revisited prior to the elections. At year end, the partial suspension of employee’s FICA withholding will expire.  There is some discussion of extending this provision to put more money in consumers’ pockets.  Our summer thriller has morphed into a holiday pageant.

You can count on a preview of coming attractions as well for 2012.  There may be a sequel to the debt ceiling debate should the select committee fail to reach its benchmark or Congress fails to agree on further cuts.  There will be a full throated roller coaster ride of the 2012 campaigns, elections and debates on the sunset or extension of tax cuts extended in December 2010.  Our little summer drama has become a multi-sequel franchise!

Spending cuts will mean less government and this also implies fewer government workers and possibly those private employees of programs dependent on this spending.  Jobs are a necessary focus of the recovery and recent indicators reflect anemic growth at best; 2011 second quarter gross domestic product growth came in at 0.4 percent, down from a revised downward first quarter.  July’s unemployment rate came in at 9.1 percent with a net increase of 117,000. Job growth is not even keeping pace with population growth; estimates are 150,000 a month needed due to population growth.  Without job creation, consumer spending remains constrained, sentiment remains dour, and demands on benefits will increase.   With this in mind, the majority of the spending cuts are back loaded, to take effect several years out, rather than immediately.    

Will the completion of the debt debate improve confidence, leading businesses to ramp up production and increase employment?  It seems unlikely that the debate inspires confidence in the legislative process and the results did nothing to improve demand for goods and services, with the exception of political commentators.  Demand for goods and services will drive private employment, not government spending cuts or tax rates.  Uncertainty is likely to be with us for at least the period of time our many thriller sequels play out through early 2013.  Slower manufacturing, stagnant wages, higher unemployment, decline in consumer spending and nervous consumers, foreign and domestic, all are contributing to slow, below trend economic growth and keep inflation well in check.  In fact, continuation of the current soft patch in the U.S. economy will keep interest rates low and place some additional pressure for stimulative measures.  

With low growth rates, the current deficit will not be fixed by economic growth and its attendant increase in revenues.  The latest spending cuts are coming from the discretionary spending portion of the federal budget.  It did not address spending on entitlement programs.  It seems very unlikely that spending cuts, if these will pass, will close the deficit or dent the debt load alone.  It seems increasingly likely that government revenues will need to be increased to work toward a long term solution.  

Just when you thought it was safe to return to the water, we have to understand that this is just the beginning.  The great white shark of the federal deficit, balance sheet, debt and budget process will return again, and again, to keep us all on the edge of our seat.  And you thought only Hollywood could produce a thriller!

David Helscher is a senior vice president and trust officer with Clinton National Bank.

This Week's Circulars