Debt Battle Pushes Economy to Brink
August 3, 2011 (Knight Ridder/Tribune Business News) The deal signed into law on Tuesday raising the nation's borrowing limit was meant to prevent widespread financial chaos that a first-ever U.S. default could have caused.
But a series of dismal economic reports, combined with continued uncertainty about America's long-term finances, triggered a major sell-off on Wall Street and had economists questioning how much damage the protracted battle in Washington may have done to the economy.
"The debt ceiling bill that was passed doesn't appear to be very well designed for the actual needs of the economy," said Richard Hoey, chief economist for Bank of New York Mellon Corp. "It was designed as a compromise among politicians, but it is to some degree an engine of uncertainty. It has added to, rather than reduced, uncertainty."
Worried investors pushed the Dow Jones industrial average down 265 points, or more than 2 percent, to 11,866, its first close below 12,000 since June. The Nasdaq and Standard & Poors 500 stock indices also were down more than 2 percent.
"The market is starting to wonder where the growth is going to come from," said Nick Kalivas, a vice president of financial research at MF Global Holdings Ltd. in New York. "It hasn't hit the panic button yet, but that's where we're drifting."
Adding to uncertainty about the economic recovery were negative reports on consumer spending, personal income and auto sales, along with weaker than expected reports in recent days on manufacturing and the gross domestic product.
Americans cut their spending for the first time in 20 months, the Commerce Department reported. Spending by consumers was down 0.2 percent in June. Income increased by 0.1 percent, the smallest gain since September.
Analysts closely watch consumer spending because they estimate it accounts for 70 percent of the nation's economic activity.
Auto sales last month ticked up but weren't strong enough to dispel doubts about the strength of economy.
"We're seeing that the consumer confidence is pretty fragile right now because of everything that's happened in the past few months," said Don Johnson, General Motors Co.'s U.S. sales chief.
U.S. sales in July were up for GM, Ford Motor Co. and Fiat-controlled Chrysler. But sales for Honda and Toyota were down more than 20 percent as Japan's March earthquake and tsunami continued to disrupt supply. As a result, overall U.S. sales across the industry last month increased by only 1 percent.
As investors retreated from stocks, gold hit a new record, closing above $1,660 an ounce. Some see the precious metal as a safe haven in uncertain economic times.
"At the end of the day, they've got an extended check and a contracting economy," said Frank McGhee, a dealer at Integrated Brokerage Services LLC in Chicago. "Every reason we've ever had to buy gold is coming up in spades."
As consumers and the government cut spending, the chances of the economy falling back into recession are increasing, according to five of the nine members of the panel that dates recessions, in which the nation's gross domestic product shrinks rather than increases. The last recession officially ended in June 2009.
"This economy is really balanced on the edge," said Martin Feldstein, Harvard University economics professor and member of the Business Cycle Dating Committee of the National Bureau of Economic Research. "There's now a 50 percent chance that we could slide into a new recession."
It's difficult to say how much the battle over the nation's borrowing limit will hurt the economy in coming months, BNY Mellon's Hoey said. But confidence, which is essential to a recovery, has clearly been shaken.
"They've been listening to the TV every night with some politician saying we could have a default," Hoey said. "That's not confidence-inspiring for consumers or business owners."