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U.S. policy makers on debt: What is this, Animal House?

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Food fight? Watching the U.S. debt crisis play out reminds me of the scene in 1978's Animal House, when Dean Wormer warns Flounder that "fat, drunk and stupid is no way to go through life, son."

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The stalemate in Washington continues today - there was no vote last night because Republican House Speaker John Boehner couldn't bring his more conservative colleagues into line - as next Tuesday's deadline to raise the government's debt ceiling approaches minute by agonizing minute.

"So the clock continues to tick down and it's now a quarter to 12 as the Aug. 2 deadline looms ever larger on the horizon, as U.S. politicians set about systematically destroying the perceived safe haven status of U.S. assets," CMC Markets analyst Michael Hewson said today as fears mounted among investors that Washington won't settle the showdown and will instead head toward a downgrade and, in the extreme, a default.

"When all this is over investors' attitude to U.S. assets will never be the same again," Mr. Hewson warned.

Here's how America's policy makers are acting like the boys from Delta House:

Fat: America has been living beyond its means - a staggering debt of $14-trillion (U.S.) - and at some point something has to give. I agree, though, with Avery Shenfeld, the chief economist at CIBC World Markets, who says we should all hope that Washington doesn't cut too deep or hike taxes because of the impact that that would have on an already slowing recovery.

Drunk: To them, it's one big party, and I'm not talking about tea. But like the partygoer who then gets behind the wheel, they're playing with the lives of others. Already, the crisis is rippling through markets, and will only get worse. In the event of an actual default, we could easily see another recession.

Stupid: U.S. policy makers solely misjudged the impact when they allowed Lehman Bros. to collapse. This time, though, voices the world over, from governments to global business leaders, are warning the U.S. of the idiocy of what it's doing.

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Here are the scenarios from Toronto-Dominion Bank economists Craig Alexander, Beata Caranci and James Marple:

  • Best case: "Congress passes the deadline and comes up with a credible long-term plan to put U.S. budgets on a sustainable track. This is increasingly unlikely at this stage in the game."
  • Missing the Aug. 2 deadline: "The impact will depend on how long it takes Congress and the president to reach an agreement."
  • A deal shortly after: "The economic impact is likely to prove temporary and will be recovered in the weeks and months following."
  • Worst case: "The U.S. defaults on its Treasury obligations causing financial havoc and leading to a global economic recession."

"The extreme conservative element within the GOP who are making Boehner's job nearly impossible should forget about a constitutional amendment to balance the budget as it would be bad policy," said Derek Holt of Scotia Capital.

"It would tie the hand of government to always engaging in pro-cyclical fiscal policy by hiking taxes and cutting spending when the economy weakens and threatens deficits, or cutting taxes and raising spending when a booming economy is feeding surpluses. That may sometimes be the way it is anyway, but I'd at least prefer the flexibility against such a straight jacketed approach."

GDP contracts Canada's recovery has stalled for two months now, the economy contracting in May by 0.3 per cent, hurt by poor weather and wildfires in Alberta.

Having come in flat in April, gross domestic product decreased in May, push down by the mining and energy sectors, and, to a lesser extent, manufacturing and construction, Statistics Canada said Friday.

"After two consecutive monthly increases, mining, oil and gas extraction fell 5.3 per cent in May," the federal agency said. "Oil and gas extraction decreased by 4.2 per cent as wildfires in Northern Alberta as well as maintenance shutdowns resulted in reduced production at oil fields."

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The manufacturing sector declined by 0.4 per cent, and the construction industry by 0.3 per cent.

"Canada's economy was hit by one thing after another in the spring, and it now faces yet another hurdle from the deepening uncertainty emanating from the U.S. debt drama," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns.

While we believe that the most likely outcome is a mild pick-up in growth over the second half, the starting point is even weaker than we expected and there are still clearly plenty of potential dangers lurking ahead for the economy."

It wasn't all bad news. Financial services and real estate eked out a 0.2-per-cent gain, helping to offset some of the poor showings on the production side.

U.S. recovery slows

The U.S. recovery is also slowing, with growth in the second quarter of just 1.3 per cent annualized, according to data released today by the U.S. Commerce Department. That's below what analysts had expected.

At the same time, the government revised its first-quarter numbers, pegging growth at just 0.4 per cent, a far cry from the earlier estimate of 1.9 per cent.

In the latest quarter, consumer spending was basically flat, rising by just 0.1 per cent.

"There's no way to sugar-coat the Q2 GDP report," said senior economist Sal Guatieri of BMO Nesbitt Burns.

"It doesn't inspire confidence in a second-half recovery and will fan double-dip fears. Hopefully it will spur Capitol Hill to get its act together before it's too late."

Senior economist James Marple of Toronto-Dominion Bank noted that cuts to government spending in the U.S. have "contributed significantly" to slower growth, pulling it down by an average 0.7 percentage points over the past three quarters.

"The one thing we can be relatively sure coming out of the debate on Capitol Hill is that government cutbacks will continue to be a factor in the outlook, putting more pressure on a private sector to support growth," he said. "However, private demand continues to be held back by a housing market that has not worked through its overhang. As a result, U.S. economic growth is likely to continue to underwhelm."

Moody's warns Spain You could see this one coming: Moody's Investors Service warned today it could take the knife to the credit rating of Spain, the fourth-biggest economy in the euro zone.

Spain is cutting fast and furious, but perhaps not enough for the agency, which said it's reviewing the country's Aa2 rating and could trim it by one notch.

"Pressures are likely to increase still further following the announcement of the official package for Greece, which has signaled a clear shift in risk for bondholders of countries with high debt burdens or large budget deficits," Moody's warned, just before Prime Minister Luis Rodriguez Zapatero called an election for November.

"The ratings agency fears that the private sector participation in the Greek deal increases the risk Spanish debt holders will face a similar fate," said Benjamin Reitzes of BMO Nesbitt Burns.

"There was also some concern regarding a weak growth outlook and fiscal slippage, especially on the local government side. (As an aside…Moody's always has the best timing with their negative announcements. Couldn't they have waited until the U.S. situation is resolved?)"

Euro zone inflation slows The euro zone's statistics agency estimates that annual inflation dipped this month 2.5 per cent, down from June's 2.7 per cent, but still above the European Central Bank's target.

Already, the ECB has raised interest rates as it puts the threat of inflation above the fight against the debt crisis in the 17-member monetary union.

Analysts keen on Potash Analysts are raising their price targets on shares of Potash Corp. of Saskatchewan after the company's stellar second-quarter results yesterday.

Brian MacArthur of UBS Securities Canada raised his 12-month target to $75 (U.S.) from $72, while Paul D'Amico of TD Securities hiked his to $68 from $65.

Yesterday, Potash posted stronger results and boosted its forecast for the year.

"The [second-quarter]result is a positive surprise and demonstrates strong fundamentals in the fertilizer sector, which should continue through [the second half]as suggested by the increased full-year guidance," said Mr. D'Amico.

"Despite the lack of a renewed potash supply contract with India, there has been and continues to be sufficient demand from other regions to offset, and support potash price leverage, in our view."

In International Business today Lacklustre lending activity in Japan's earthquake-ravaged economy and a shrinking retail investment business capped earnings of the country's top banks and brokerages in the fiscal first quarter, raising pressure on them to take more risks and find revenue sources overseas. Tom Kelley and Taiga Uranak of Reuters report from Tokyo.

In Economy Lab today Of all the numbers tossed about in Washington's debt fight, one looms larger than all others, and not only because of its size: $4-trillion (U.S.). The figure has become something of a Holy Grail, the magic number that would end the angst over the U.S.'s massive budget shortfall. The Globe and Mail's Kevin Carmichael reports from Washington.

From today's Report on Business

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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