The bipartisan Congressional super committee announced on Monday that it would not be able to reach a deficit-reduction deal in time for its deadline this week. The committee’s failure will not unleash a near-term economic catastrophe, but it does have four important implications for the US economy.

1. Lower Investor Confidence: In the near term, failure to reach a deal will further undermine already fragile investor and business confidence.

2. A Stalled Economy in 2012: It also raises the likelihood that the economy will stall next year. Why? Failure to reach a deal makes it less likely that government economic stimulus will be extended into 2012. In the absence of an extension of the payroll tax holiday and extended unemployment benefits, US consumers will lose roughly $150 billion of disposable income in 2012.

3. Fiscal Drag in 2013: Failure to reach a deal means that fiscal policy will remain stagnant. In the absence of a change to fiscal policy, the US economy will be facing a significant fiscal drag in 2013 when the automatic sequester is set to kick in just as the Bush tax cuts are expiring.

4. Another Potential Downgrade: Thanks in part to its reserve currency status and what appears to be an impervious reputation as a safe haven, US political paralysis has resulted in more liquidity not less, i.e. bond yields perversely drop every time the United States fails another budget milestone. But while the United States can fund its deficit for now, its credit quality, as well as credibility, is falling fast. The continuing failure of politicians to address our budget issues in a meaningful way raises the risk of another downgrade to US debt. While another downgrade may not matter much in the near term, Europe’s current situation shows it could have serious consequences in the longer term.

(c) iShares Blog

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