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Thursday, January 3, 2013

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Economic Events of the Week

Thursday – Jobless Claims, ADP Employment Report
Friday – Employment Situation

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e21 Reaction & Commentary
e21 Commentary: Fiscal Cliff Deal Moves Nation Closer To Bankruptcy

Washington Update
Why 85 House Republicans Said ‘Yes’ To Taxes (Politico)
Has The ‘Fiscal Cliff’ Fight Changed How Washington Works? (The Washington Post)
Lawmakers Eye Policy Actions On Debt Limit (CQ)
Moody’s To Congress: Further Fiscal Steps Needed (National Journal)

Market Talk
Outlook For 2013 Improves As U.S. Manufacturing Climbs (Bloomberg)
Deductions Limits Will Affect Many (The Wall Street Journal)
The Economy’s Trajectory in 2013 (Econbrowser)

Editorials & Opinions
The Fed's Dangerous Direction (Martin Feldstein in The Wall Street Journal)
US Has Been Let Down By Its Leadership (Financial Times)
Repealing Reagan (Daniel Henninger in The Wall Street Journal)

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e21 Reaction & Commentary

e21 Commentary: Fiscal Cliff Deal Moves Nation Closer To Bankruptcy

The nation’s political establishment has ridiculed the fiscal cliff deal for its failure to make the tough decisions. But what tough decisions are possible when one party to a negotiation doesn’t think they need to be made? Speaker Boehner has repeatedly cited the President Obama’s refusal to countenance spending cuts as the reason talks on a “grand bargain” kept breaking down. The President offers token programmatic changes that would do nothing to alter the long run debt trajectory in exchange for tax increases on the most volatile, least reliable segment of the income base. The President wants both to spend too much and then collect far too little in taxes to pay for it. This negligence will ultimately end in disaster. According to the IMF, to achieve a public debt level consistent with long-run solvency, the U.S. must achieve a fiscal adjustment of 17.9% of GDP ($2.7 trillion in 2013 dollars) between 2014 and 2020. This would require immediate budget savings of about $600 billion per year, increasing at a rate of about $400 billion per year for the next five years. This is about 3x as much cumulative deficit reduction as the $4 trillion figure typically used in “grand bargain” discussions and it excludes the associated interest savings that President Obama wants to credit. The President is not only not contemplating deficit reduction on this scale, but actively trying to stop it. The Speaker’s top goal in negotiations is to cut entitlement benefit schedules by a magnitude necessary to achieve long-run solvency; the President’s top priority is thwarting such an outcome. This ensures that when the crisis actually occurs, cuts will come suddenly, unexpectedly, and will involve more pain and dislocation than had they been consciously planned in calmer times.


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Washington Update

Why 85 House Republicans Said ‘Yes’ To Taxes (Politico)

It was one of the toughest votes they’ve had to cast in their congressional careers. But here’s why 85 House Republicans broke with most of their GOP colleagues — and decades of anti-tax orthodoxy — to back President Barack Obama’s tax hike bill: Their districts are conservative — but not so conservative that jumping off the fiscal cliff wouldn’t potentially backfire in the next election. A general-election challenge from the left is a bigger threat than a primary from the right. And being able to tell most of their constituents they shielded them from a big tax hike was more important than being accused by a vocal few of selling out Republican principles. “The ability to go home and say, ‘We found a solution, no matter how messy it may be,’ is an asset to them,” said Brian Walsh, former political director of the National Republican Congressional Committee. “It’s because of the types of districts they come from.” “The list of ‘yes’ votes is filled with moderates — those folks largely focused on the general election in 2014,” Walsh added. Pennsylvania Rep. Mike Kelly, who occupies a seat in the western part of the state, said supporting the package — as unpalatable as it was for the Republican faithful — was far more palatable than veering off the cliff.

Has The ‘Fiscal Cliff’ Fight Changed How Washington Works? (The Washington Post)

As ugly as they were, the “fiscal cliff” negotiations produced something Washington hadn’t seen in a long time: strongly bipartisan votes in the House and the Senate on a big, contentious issue. The question now is whether that victory of pragmatism over ideology offers a new model of governing as President Obama approaches his second term and the shattered Republican Party tries to regroup. The answer: probably not, though it may have helped define the terms of engagement for the battles to come. “We’re still in a pretty fluid period as to how and whether the two sides can work together,” Rep. Tom Cole (R-Okla.) said Wednesday. White House officials see the deal brokered this week as a critical short-term victory with long-term consequences — forcing House Republicans to surrender on one of their party’s core tenets. The agreement, approved with comfortable bipartisan majorities on New Year’s Day, raised taxes on net income over $400,000 while holding rates steady for income below that amount.

Lawmakers Eye Policy Actions On Debt Limit (CQ)

With the fight over fiscal cliff issues only just resolved, the battle lines already are being drawn and important policy and economic implications measured for a coming showdown on the federal debt ceiling. The federal government is expected to run out of borrowing authority by the end of next month, and both parties are readying a high-stakes game of chicken, with Republicans hoping to leverage new spending cuts in return for a debt limit increase and Democrats promising to hold firm in opposition. Less than 30 minutes after the House cleared fiscal cliff legislation, President Barack Obama reiterated his vow not to bargain for an increase in the debt limit as he did in 2011. And he warned that a government default would dwarf the threat of the just-averted tax and spending cliff.

Moody’s To Congress: Further Fiscal Steps Needed (National Journal)

Moody’s Investor Service warned Washington Wednesday not to rest on its haunches after its New Year’s Day passage of legislation to avert the fiscal cliff, arguing more work must be done to meaningfully lower the U.S. debt trajectory and prevent the risk of a downgrade of the U.S. debt. The credit rating agency issued a note analyzing the impact of the fiscal package agreed to Tuesday, crediting it for taking measures to head off an anticipated recession, but criticizing it for key shortfalls. “The recent package mitigates part of the fiscal drag on the economy associated with the fiscal cliff but does not eliminate it,” the rating agency said. Namely, Moody’s lamented that the fiscal cliff deal fails to provide “meaningful improvement in the government’s debt ratios over the medium term” and fails to address the U.S. borrowing authority, which hit its limit earlier this week and is projected to need an increase within the next couple of months once “extraordinary” measures to keep Treasury payments going, have run out.


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Market Talk

Outlook For 2013 Improves As U.S. Manufacturing Climbs (Bloomberg)

Manufacturing picked up in December, reflecting growth in orders, employment and exports that indicate the U.S. expansion will be sustained in 2013 following the budget deal. The Institute for Supply Management’s manufacturing index climbed to 50.7 from a three-year low of 49.5 in November, the Tempe, Arizona-based group reported today. Fifty is the dividing line between expansion and contraction. Other data showed fewer outlays for non-residential projects pushed down construction spending in November for the first time in eight months. A rebound in housing and stabilization in global growth point to a pickup in sales that will boost companies such as General Electric Co. Stocks surged, sending the Standard & Poor’s 500 Index to its biggest rally in a year, as Congress passed a bill averting spending cuts and tax increases that threatened to push the world’s largest economy into a recession. “We are starting the new year on at least a fairly firm note,” said Tim Quinlan, an economist at Wells Fargo Securities LLC in Charlotte, North Carolina, who projected the ISM index would climb to 51. While some manufacturers have been holding back because of the budget debate, he said, “there is demand in this economy. As soon as businesses are able to take advantage of this, we’ll see a bigger contribution from manufacturing to overall economic growth.”

Deductions Limits Will Affect Many (The Wall Street Journal)

One of the biggest tax increases in the fiscal-cliff bill is also one of the least understood: a set of limits on tax deductions and other breaks that will hit far more households than the bill's rate increases for top earners. The bill that cleared Congress Tuesday boosts the tax rate for single filers making more than $400,000 and married couples filing jointly making more than $450,000, or roughly the top 1% of filers. But provisions that reduce the value of personal exemptions as well as most itemized deductions, including those for mortgage interest and state income-tax payments, will affect about twice as many people since they carry a lower income threshold—$250,000 for singles and $300,000 for married couples. Those new limits drew complaints from some groups that benefit from deductions, particularly charities that depend on tax-deductible donations. They worry that new curbs on deductions, coupled with other taxes on higher-income Americans, will put a damper on giving.

The Economy’s Trajectory in 2013 (Econbrowser)

The agreement arrived at on New Year’s day implies that output at the end of 2013 will be between 0.6 to 1.0 percentage points higher than it otherwise would be under what was until New Year’s, current law, according to CBO’s preferred multipliers. The uncertainty arises in part from the unresolved nature of the sequester deal. 4 quarter growth by 2013Q4 would be 1% (conditional on the CBO's August 2012 forecast)assuming the sequester is held in abeyance. If the sequester is fully put into effect, growth would be under 0.6%. These are calculations based on the CBO’s preferred multipliers; it’s likely that the multipliers are higher, given the accommodative nature of monetary policy. Using the high multiplier estimates, and assuming that no sequestration eventually occurs, then growth would be 2.3% 4q/4q. Working in the opposite direction is uncertainty. Given that the sequester issue and debt ceiling increase will come up in two months, one could reasonably expect that policy uncertainty will persist (exactly the concern many conservatives have highlighted over the past years).


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Editorials & Opinions

The Fed's Dangerous Direction (Martin Feldstein in The Wall Street Journal)

The Federal Reserve is heading in the wrong direction. What the central bank describes as "unconventional monetary policy" is creating dangerous bubbles in asset markets that will lead to higher future inflation and is supporting the explosive growth of the national debt. Its new "communications strategy" will, moreover, only further confuse markets. The Fed's recently announced plan to buy $85 billion a month of government bonds and mortgage-backed securities will keep long-term interest rates at historic lows, with a 1.6% yield on 10-year Treasurys and a negative yield on 10-year TIPS (Treasury Inflation-Protected Securities). The Fed sees its strategy as a way of boosting the prices of equities, real estate and other assets. It has indeed boosted asset prices, although the increase in individual balance sheets has had very little positive impact on real economic activity.

US Has Been Let Down By Its Leadership (Financial Times)

The deal reached in Washington on New Year’s day prevented the US economy from falling off the so-called fiscal cliff. However, given the dysfunctional nature of the American political system, it won’t be long before there is another crisis. Two months, in fact. If no action is taken by March 1, $110bn of spending cuts will commence. At about the same time, the US will hit its statutory debt limit, known colloquially as the debt ceiling. That is only the beginning. Later in 2013, and not before time, a bigger debate on medium-term fiscal consolidation will begin. This will lead to another dispute between Republicans, who want to shrink the size of the federal government, and Democrats, who want to maintain it but are unsure how to pay for it. So expect a big fight about entitlements, and a series of little fights over tax reform: should the US introduce a value added tax? A flat tax? Higher (or lower) income taxes? A carbon tax? Should we close corporate tax loopholes to raise more revenue? It’ll soon get messy.

Repealing Reagan (Daniel Henninger in The Wall Street Journal)

Legend had it in Ohio years ago that when a baby boy was born in the perennial high-school powerhouse city of Massillon, a small football was placed in the cradle. The kid knew what was expected of him. When Ronald Reagan signed the Tax Reform Act of 1986, Barack Obama was a 25-year-old community organizer in Chicago. Like all progressives born now in America, the young fella knew what was expected of him if he got the chance. Repeal Reagan. For the past 25 years, the American left has lived and breathed the political goal of undoing the Reagan legacy on taxes and spending. On Jan. 1, 2013, they did it. Until 2016, tax reform is dead. Reagan's philosophy was an anathema to the left. It was his novel postwar idea to make people less in thrall to Washington's investment choices and more reliant on their own ideas for using capital. The '86 tax act reduced tax rates on personal income and also famously gutted many nonproductive "tax shelters." In short, simplification. It was also bipartisan. The assault on loopholes—which were often promoted by pre-Reagan Republicans—was led by Chicago Democrat Dan Rostenkowski, chairman of the House Ways and Means Committee.


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