Implications of the fiscal cliff

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Source: John D. Anderson, Deputy Chief Economist, American Farm Bureau Federation

Last week, Jim Robb used this space to discuss the supply side of the supply/demand equation in the cattle market.  Let’s take a quick look this week at an issue of some relevance to the demand side of the market: the direction of the general economy.  A couple of recent reports indicate that the economy appears to be – still – fairly fragile.

Last week, the National Restaurant Association released their widely-followed Restaurant Performance Index (RPI) for October.  The RPI is of particular interest to the beef industry since so much beef is consumed away from home in food service settings, but it is also of more general interest as an indicator of consumer sentiment in the broader economy.  The most recent RPI release generated a bit more attention than normal because the RPI fell to a value of 99.5 – its lowest level in 14 months.  RPI values below 100 suggest that the restaurant trade is experiencing or is anticipating a contraction in business.  The press release from the National Restaurant Association accompanying the RPI indicated that restaurant operators had become decidedly more pessimistic in their short-term outlook.  Also on the topic of pessimism in the short-run outlook, the Institute of Supply Management released a widely-followed monthly indicator on Monday this week: the ISM Purchasing Managers Index (PMI).  This index summarizes the activities of the purchasing managers (the people who buy the raw materials) for manufacturing firms and is thus considered a leading economic indicator.  The PMI for November fell below 50 in November, indicating contraction in the sector.  At 49.5, the PMI posted its lowest reading since July 2009 and was well below expectations that it would hold steady for the month at just under 52.

One of the major sources of uncertainty in the economy right now is the direction of federal fiscal policy.  As anyone who has not just awakened from an 18 month coma knows by now, the federal government is facing the automatic implementation of substantial tax increases and spending cuts at the end of the year – the Fiscal Cliff.  The fiscal cliff actually results from the convergence of a number of related policy tracks.  Partly it is the endgame for the Budget Control Act of 2011 (BCA).  According to the terms of the BCA, if an ad hoc congressional super-committee (the Joint Select Committee on Deficit Reduction) failed to devise and pass through the full Congress a revenue package that would reduce the deficit by $1.2 trillion dollars over ten years, a pre-established set of spending cuts would automatically kick in on December 31, 2012.  Shockingly, Congress did, in fact, fail to agree to an acceptable package, and now the automatic provisions are about to kick in.  Partly the fiscal cliff is a consequence of the scheduled expiration of the Bush-era tax cuts and of the temporary payroll tax cut.  These cuts weren’t part of the BCA, but due to some perplexing policy choreography, their expiration coincides with the BCA’s sequestration provisions.  Finally, the Affordable Care Act included some revenue-raising tax code changes that were scheduled to kick in at the beginning of 2013, just in time to join the Bush tax cut expiration and the BCA’s automatic spending cuts. 

Leaving aside questions on the merits of any of the particular policies comprising the fiscal cliff, it is clear that the combined tax increases and spending cuts all taking effect at once would represent a significant shock to the economy.  In a report on the issue released in early November, the Congressional Budget Office (CBO) estimated that the combined effect of the tax increases and spending cuts in sequestration would be sufficient to push the economy back into recession in the first half of 2013, resulting in a decline in GDP for next year of about 0.5%. 

A return to overt economic contraction would be a step down from our present position of barely-perceptible recovery.  But we really don’t have to go off the fiscal cliff to get a glimpse of its effects.  Markets are anticipatory – market participants’ expectations of the future influence today’s decision making.  For this reason, the risk of a looming fiscal crisis is already affecting the economy.  Federal Reserve Board chairman Ben Bernanke made that point clearly a few days ago in a speech to the New York Economic Club:

“Uncertainty about how the fiscal cliff, the raising of the debt limit, and the longer-term budget situation will be addressed appears already to be affecting private spending and investment decisions and may be contributing to an increased sense of caution in financial markets, with adverse effects on the economy. Continuing to push off difficult policy choices will only prolong and intensify these uncertainties.”[1]

The recent declines in the forward-looking RPI and the PMI indicators suggest that Chairman Bernanke is on to something.  It is a mistake to think that the current political/fiscal uncertainty hasn’t already cost us something.  It has.  But it could get worse.  The issue truly is a thorny one, as Bernanke points out.  Something has to be done to improve the country’s long-run fiscal situation: current deficits are not sustainable and will inevitably choke off economic activity at some point.  However, moving too aggressively on the issue could substantially set back an already fragile economy – making our fiscal problem even harder to deal with in the short run.  As of this writing, there is no indication at all how this delicate situation will be resolved.  No doubt, Congress and the White House are hard at work on it, but so far the conversation is generating a lot more heat than light.  The positions of the President and the Speaker of the House seem to be about the same as they have been for over a year now.  At some point, somebody has to come up with something new.  Bear in mind, though, that the last brilliant idea for addressing these issues was the Fiscal Cliff that we are all wringing our hands over now. 

On a happier note, since this is my last ICM contribution of the year, I would like to take the opportunity to wish everyone a Merry Christmas. 

The Markets

Fed cattle prices slipped last week, but the lower prices didn’t entice just a whole lot of sellers.  The 5-Area price for last week worked out to $125.79, down from $127.30 for the prior week.  Negotiated sales volume was off sharply from the prior week (a short holiday week) and from a year ago.  Feeder/stocker prices were called firm to $5 higher in last week’s national summary from USDA.  Prices on lighter weights were noted to be decidedly mixed last week, ranging from $10 higher to $10 lower.  The volume of calf sales was large last week – well over 300,000 head in the national summary – and comparable to year-ago levels despite all the early movement of cattle this year.  Wholesale meat prices were fairly stable this week.  The comprehensive boxed beef cutout last week averaged $188.71, up less than 50 cents from the prior week.  Encouragingly, the pork cutout was up last week – averaging $84 for the week versus $81.63 the prior week.  Higher than expected pork production through much of the last half of this year has kept pork very competitively priced.  A bit of recovery in pork prices would be a welcome development for the beef sector.

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[1] Bernanke, Ben S.  “The Economic Recovery and Economic Policy.”  Speech to the New York Economic Club, November 20, 2012, New York, NY.  Online at http://www.federalreserve.gov/newsevents/speech/bernanke20121120a.htm.


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