GLOBAL ECONOMY-U.S. runs out of road as fiscal cliff looms

Alan Wheatley, Global Economics Correspondent
Reuters Middle East

* Fiscal tightening would hit U.S., world economy hard

* Deadlock dims hopes for housing-led recovery

* Abe cabinet to take office pledging to reflate Japan

LONDON, Dec 23 (Reuters) - The wheels could come off the

U.S. economy even before it has shifted out of second gear

unless politicians reach a last-minute deal to avoid $600

billion in tax rises and spending cuts that kick in next month.

The rest of the world would be unable to avoid the pile-up

if America does fly off the so-called fiscal cliff.

That is why, even in a holiday-shortened week, eyes will be

peeled for signs that Democratic President Barack Obama and his

divided Republican opponents can bury the hatchet.

The White House on Friday tried to rescue the stalled talks,

but there was little headway to resolve what Alan Blinder, an

economics professor at Princeton University, called the biggest

near-term risk facing the global economy.

Seen from abroad, U.S. policymakers were looking "clownish",

the former vice-chairman of the Federal Reserve said: "This will

do us a tremendous amount of damage."

Until last Thursday, markets had assumed a compromise would

be struck, averting the risk of a relapse into recession. The

slow-motion car crash had been so well signaled that surely the

drivers would swerve in time?

But after Republicans abandoned a fix proposed by House of

Representatives Speaker John Boehner, businesses and households

head into the year-end knowing the clarity they crave on tax and

spending plans could be weeks away.

"The longer uncertainty persists, the greater the negative

impact on the economy," Lewis Alexander, chief U.S. economist at

Nomura, told clients.

"It may take the imminent threat of a breach of the debt

limit in February, or March at the latest, to force an

agreement," he added, referring to the Congressional approval

that the Treasury will need to extend its borrowing authority.


By sapping consumer confidence, the political brinkmanship

could already be enough to sap short-term U.S. growth.

If America then does tumble over the cliff for more than a

few days, triggering fiscal tightening that could reach 4

percent of GDP, the repercussions would be felt around the world

via trade and financial links.

"If our economy goes into a recession, especially a serious

recession, a deep recession, that's going to hit imports from

the rest of the world. And to the extent that it messes up

financial markets, that has a contagion effect," said Martin

Feldstein, an economics professor at Harvard University.

Like Blinder, he was speaking on a conference call organised

by Foreign Affairs magazine.

Indeed, the resulting turbulence in financial markets could

end the period of relative calm enjoyed by the euro zone, said

Christian Schulz, an economist at Berenberg Bank in London.

Failure to put the U.S. budget on a more sustainable path

could well crush hopes that the world's largest economy is

finally shaking off the effects of the financial crisis and

returning to a path of steadier if not spectacular growth.

Credit Suisse on Friday raised its forecast for

fourth-quarter gross domestic product growth to an annualised

pace of 1.8 percent from 1.1 percent after consumer spending in

November rose at the briskest rate in three years.


A recovery in housing is an increasingly important motor of

growth, and figures on Thursday are expected to show new home

sales rose to 380,000 in November from 368,000 in October,

according to economists polled by Reuters.

Two of the top trading recommendations for 2013 by

economists at Goldman Sachs are premised on a deepening housing

market recovery. Existing homes changed hands in November at the

quickest pace in three years, while confidence among U.S. home

builders rose to a 6-1/2-year high in December.

Edward Jamieson, chief investment officer in Franklin

Templeton's equity group, said housing was benefiting from

record-low interest rates, a gradual reduction in household debt

and significant pent-up demand.

"Higher home prices have also helped reduce the number of

individuals with negative equity in their homes while also

providing a strong wealth effect, which we think bodes well for

continued improvement in the housing sector," he said in a


That markets in the last days of 2012 should be held hostage

to events in Washington is fitting in one sense: this has been a

year in which politics has shaped economic developments more

than ever.

In the euro zone, a commitment by paymaster Germany to keep

bailing out backsliding Greece, building on a pledge by European

Central Bank President Mario Draghi to do whatever it takes to

preserve the euro, largely allayed market doubts about the

imminent disintegration of the single currency.

In Japan, Prime Minister-elect Shinzo Abe, whose cabinet

will be sworn in on Wednesday, campaigned on a platform of more

aggressive monetary and fiscal policy to jolt the economy out of

two decades of anaemic growth and gently falling prices.

The yen has weakened and Japanese stocks have risen in

response even though many are sceptical that Abe will introduce

the reforms Japan needs.

The Bank of Japan, sensing which way the political winds are

blowing, duly relaxed policy last week, and inflation figures on

Friday are likely to reinforce expectations that there is more

to come from the central bank.

Economists polled by Reuters expect core prices to have

fallen by 0.1 percent nationwide in the year to November and by

0.5 percent in Tokyo in the year to December.

"We expect quantitative easing to continue aggressively in

the first half of 2013, especially after a new governor takes

the helm from the April 26 monetary policy meeting," Izumi

Devalier, an economist with HSBC, wrote in a report.

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