Comment: The Key Downside Economic Risk

S&P's David Blitzer was on CNBC this morning and said:

"The big issue is the debt ceiling, the budget deficit, the U.S. Congress," Blitzer said in a "Squawk Box" interview. "It's the whole fiscal policy side that's the huge problem. ... I don't think we're going to default but I think we're going to have one of these crazy 11th-hour skirmishes."

"Everybody will decide the U.S. Congress is even worse than their worst nightmare and the markets will get hit as a result," Blitzer added. "It'll be worse than the J.C. Penney board situation because there will be 535 of them."

At the beginning of the year, I wrote Question #1 for 2013: US Fiscal Policy "[U.S. fiscal policy] is probably the biggest downside risk for the US economy in 2013." If anything I was too optimistic. I thought there would be some sort of compromise on the sequester budget cuts - I was wrong, although I was correct on the debt ceiling. Now here we go again ...

If we all lived in a sane world, the "debt ceiling" would be eliminated (see discussion here), we'd all recognize that the deficit is declining quickly (probably too quickly), and that the sequestration cuts are crazy (OK, on the last one, just about everyone admits the cuts are dumb).

The negotiations this year should be easy - eliminate the sequestration cuts and don't do anything else in the short term (there are long term issues, but I doubt we will see progress there).

Unfortunately we live in the real world, and politics trump reality.  Note: For a discussion of many of the budget issues this year, see Stan Collender's Budget Bedlam This Fall

Still - even in the insane world of politics - the debt ceiling is a fake issue (the House will cave again - they have no choice).  And hopefully we will not see a government shutdown, but I expect the negotiations will go down to the wire. My guess is we will see another "continuing resolution", but you never know with politics.

The good news is these showdowns mostly happen in odd years with the hope that the voters will forget the congressional shenanigans by the next election.    So IF we can get through the fall, fiscal policy will probably not be a big downside risk in 2014.  Unfortunately that is a big "if".