It is hard to decide which barrier to economic recovery to be most worried about today: The Japanese industrial collapse, inflation from soaring commodity prices, the emergency financial aid requested by Portugal, or the threatened partial shutdown of the federal government at midnight. All of the headwinds battering the economy are gusting today. Crude oil has jumped to over $111 / bbl. on the shutdown of Libyan oil production and the continuing protest demonstrations on the fringe of the Arabian Peninsula. Japanese manufacturers announced factory reopening plans that keep production far below normal for at least of month and then depressed for at least several more months. Portugal has become the fourth European country unable to service its massive debts from over spending. A partial federal shutdown is now probable with no compromise yet on how much to cut federal spending.
The economy could shake off a brief gust from any one of these headwinds with no measurable impact over a quarter. We probably will not be this lucky. We should expect some problem from each of these four areas with a significant risk that one or more of problems could be very serious or prolonged. And in the background, state and especially local governments continue to slash spending to match available funds. Economic growth in the middle of 2011 will be weak and could average only near 2.0%.
The European debt crisis poses the least risk to the US. Portugal is a small country. The larger European countries will lend them what they need to avoid bond defaults and give then more time to implement painful spending cuts. This will not end the public deficit problem in Europe. Spain and Italy are also at risk of defaulting if spending cuts do not continue on the announced schedule. A Portugal only problem will be barely noticeable in the US but the impact will be a few tenths of a percent of GDP growth if the problem spreads to Spain or Italy.
Higher commodity prices, mostly oil but also metals and food, are already cutting US GDP growth by at least 0.3%. This could double if the problem persists for several more months as buyers adjust to higher permanent prices and become more cautious about spending. The negative impact will jump over a full percentage point if oil production is disrupted or seriously threatened in the Arabian Peninsula. This still appears to be unlikely but will remain a low level threat for at least through the summer.
The scale of the Japanese disaster is now known and the timeline for recovery is becoming clearer although it will not be fully known for several more weeks. The radiation scare in the US appears to be over. This removes a huge negative impact on consumer confidence and spending. How quickly electricity generation can be restored in Japan is the key remaining unknown. Undamaged nuclear power stations remain shutdown as a precaution. Manufacturing, investment and consumption in Japan are beginning to recover. This will be a long process with “normal” many months ahead.
The hit to US exports and the disruption of US manufacturing has been very marginal so far as products in transit have been delivered to Japan and inventories of Japanese products and parts have been drawn on to sustain US factory operations. The negative impact on then US will progressively worsen in April and May and possibly a little longer. Shortages of Japanese products at retailers and wholesalers will become obvious but much of the cost to the US economy will not be in public view. Supply expediting and substitutions within US companies and out of public view will be expensive.
Profits and hence investment will suffer much more than product sales or production.
The impact of the Japanese disaster on the US economy will be at least several tenths of percentage point of GDP growth in the current quarter, will linger into the summer quarter and likely will still be significant at yearend.
With the battle of Madison over, state and local government cuts has disappeared from national headlines. But the debate over how much to cut remains in local headlines throughout the country. Advocates for preserving public spending levels have lost major battles in Wisconsin, Ohio, Indiana, Michigan, Illinois, New York, New Jersey, Florida and Texas as well as other smaller states and at the municipal level. These legislative cuts come into effect slowly; many begin on July 1st. The impact on GDP growth was marginal in the fourth quarter, will expand to several tenths of percent in the winter quarter and become even larger in the middle of 2011.
The impact of federal spending cuts, either a legislative compromise or a partial shutdown while compromise is negotiated, is the most uncertain. Both the magnitude and timing are uncertain. There is little change that the final, decisive battle will take place today. A series of small spending cuts with the final battle postponed to the 2012 election will result in a marginal direct impact, perhaps 0.1% GDP decline but a large negative impact from the depressing effect of delaying a final solution. A prolonged shutdown would aggravate the loss of spending because it disrupts the flow of federal permissions to the private economy. This impact would be brief but very severe and could halt employment gains for a month.