The much talked about sequestration is upon us. It is going to go into effect on March 1 unless the President and Congress agree to an alternative plan. The market is betting that they will “kick the can” down the road again, and such, are ignoring the political rhetoric that is slowing building up in Washington DC.
How did we get here? It started with debt ceiling negotiation in the summer of 2011, which culminated in the Budget Control Act (BCA) of 2011. BCA created a Super-Committee, and the failure of that committee led to the sequester.
On April 4, 2011, the Treasury Secretary wrote a letter to Congress saying that $14.294 trillion debt limit had been reached. On May 16, 2011, the Treasury suspended debt issuance and took extraordinary measures to meet government obligations. The Treasury notified Congress that such measures could only last until August 2, 2011, at which time the US will run out of money to pay its bills. After much wrangling, Congress and the President agreed to a plan, which was incorporated in the Budget Control Act (BCA) of 2011. The President signed BCA on August 2, 2011. BCA raised debt ceiling by $900 billion. Another $1.2 trillion could be raised but that required equal amount of spending cuts. It created a super-committee to help decide the $1.2 trillion of cuts. If the super-committee failed, automatic cut or sequestration will kick in on January 2, 2013. The super-committee failed. Just before the sequestration was supposed to kick in, Congress and the President agreed to another deal (American Taxpayer Relief Act of 2012), which delayed the implementation by 3 more months. That’s how we got here.
The sequester will cut $1.2 trillion over 10 years, or ~120 billion a year – around half comes from defense and the other half from non-defense including Medicare. According to the Bipartisan Policy Center, the impact of the cut to 2013 GDP is ~0.5% and around 1 million jobs during 2013-14.
My own feeling is that if the sequester were to hit fully, the impact will be significantly larger because of secondary/tertiary impact as well as the impact on consumer/business sentiment. Always remember that the Fed Chairman Bernanke said the impact of sub-prime mortgage is only ~100 billion in July 2007; the real impact was more like ~15x that.
