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POLITICAL ECONOMY
Outside View: Risking economic depression
by Peter Morici
College Park, Md. (UPI) Aug 9, 2012


disclaimer: image is for illustration purposes only

U.S. President Barack Obama and congressional Republicans are engaging in dangerous brinksmanship. Putting off addressing the fiscal cliff until after the election risks a second Great Depression.

Without a compromise by January, $400 billion in mandatory spending cuts and more than $100 billion in tax increases immediately go into effect. With gross domestic product only growing $300 billion annually, such a shock would thrust the economy into prolonged contraction.

With the federal deficit already exceeding $1 trillion, additional stimulus spending significant enough to rescue the economy is unlikely and interest rates are already at record lows. These leave policymakers with few tools once things start unraveling.

However, Obama has given Republicans few political choices but to roll the dice.

Facing re-election, Obama promises to veto any extension of Bush-era tax cuts for middle-income Americans if Congress doesn't raise rates on upper-income families. He won't entertain meaningful cuts in entitlement spending or healthcare.

Even if Obama wins in November, he likely will be saddled with a Republican House.

Armed with a mandate, he will get higher taxes on upper-income families. However, he has made commitments to expand the U.S. naval resources in the Persian Gulf and Asia to counter Iran and China. He can't finance those without giving Republicans some of the entitlement reforms they want but can't get now.

For the U.S. economy, one of three outcomes is likely.

Obama wins but doesn't reach a deal with Republicans before February or March. Mass layoffs begin late this fall, especially in the defense sector, and the economy stumbles badly.

Obama wins and deals with Republicans in Congress by late December. Taxes go up, and overall spending is cut, but not as much as current legislation requires. The combination still derails the fragile recovery.

Former Massachusetts Gov. Mitt Romney wins and implements a pro-growth agenda but the current situation is too urgent to wait for actions that won't take effect until at least next spring and summer.

Businesses are already curtailing investments in machinery and information technology as a hedge against a contracting economy in 2013 and consumers are spending less. Retail sales fell each of the last three months.

The Great Recession was caused by manifest structural problems in the economy: a wide trade gap with China and on oil, banks that had forgotten how to earn profits through sound lending, failed financial regulations and skyrocketing healthcare costs.

Obama's policies have mostly exacerbated those problems. That's why the recovery is so weak and a second recession now could put the economy down for good.

Too many young adults unemployed or in poorly paying jobs are living with aging parents. Many older Americans are running down individual retirement accounts before reaching retirement age, hoping for better days.

The safety nets provided by parents and savings will soon tear. If the economy goes down again, the negative feedback cycle of fewer jobs, less spending, more layoffs and so forth will be much more severe than in 2008.

The hallmark of a depression is a recession that doesn't sow seeds of recovery by creating pent up demand for business and consumer durable goods. Truck and car replacements played a mighty roll in the most recent recovery.

With many Americans slipping from the middle class, businesses may simply downsize for a permanently smaller U.S. economy and families will own fewer vehicles, appliances and electronic toys.

Unemployment in the range of 15 percent easily could become the new normal.

Obama should risk upsetting his base and offer Republicans in Congress a reasonable deal now.

Republicans should admit what they already know -- Mitt Romney is no messiah -- and take the risk of compromising now.

American can't afford for their elected officials to dither any longer.

(Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist.)

(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)

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