03/01/2013 05:28 pm ET

The Case for an Investment Boomlet: Barring a Government Misstep

Washington-based Risks
As I wrote in my February newsletter, Themes on the Economy, investment is not only critical to growth this year, but to growth in the future. If we don't invest today, there will be nothing to build a foundation on going forward. The good news is that investment appears to be coming back. Corporate balance sheets are as strong as ever; factories idled during the housing bust are being reopened and upgraded; onshoring is bringing production home again; and, the damages caused by Superstorm Sandy, especially to critical infrastructure, must be repaired.

The bad news is that missteps by Washington could easily derail that momentum. Threats of sequestration, which include more than $100 billion in spending cuts, mostly to defense and healthcare, are particularly risky at this stage of the recovery. Macroeconomic Advisers and the Congressional Budget Office estimate that:
  • A full sequestration, including more than100 billion in across-the-board spending cuts, would shave roughly 0.75% from real GDP growth this year. That would eliminate any major improvement in labor markets and could cause a setback in unemployment.
  • A shutdown of government would cost us 0.25% in real GDP growth per week that it lasts in the second quarter.
  • Uncertainty associated with a showdown over the debt ceiling could shave 0.5% from growth in 2013.
  • Failure to raise the debt ceiling would push the U.S. economy into the deepest recession since the Great Depression and dramatically raise the costs of borrowing.

Resolutions reached over the fiscal cliff debate on December 31 and January 1 suggest that some in Washington are learning that there is more to be gained by compromising than stonewalling. Moreover, there seems to be some movement on both sides of the aisle on taxes and spending. The President has acknowledged the need to cut spending more thoughtfully, to avoid draconian cuts associated with sequestration, while there appears to be bipartisan support for closing loopholes and lowering the corporate tax rate, even if that means higher revenues.

Washington has failed us more than once so threats to move forward on sequestration should still be taken seriously. The great unknown is the damage to business confidence triggered by another failure, even if it is short-term, in D.C.

Separately, Moody's and Fitch have threatened to lower our credit rating more than Standard and Poor's did in 2011, if gridlock persists. That would tighten credit conditions across the board.

NOTE: The U.S. government is suing Standard and Poor's for inflating its ratings on subprime mortgages during the housing bubble. If the government wins, other
S & P ratings, including the downgrade to U.S. debt made in August 2011, could be challenged. That also could act as a deterrent to other rating agencies, but all are clearly playing with fire.

Read all of Themes on the Economy, including this excerpt.