Feb. 25 (Bloomberg) -- Government spending cuts set to take effect this week will be felt at the local level as everyone from defense contractors in Virginia to waitresses in New Mexico take a hit. The overall impact on the U.S. economy may be more muted.
“There is pain that is going to be spread around,” said Mark Vitner, a senior economist at Wells Fargo Securities LLC, in Charlotte, North Carolina. “Areas that have a great deal of exposure to government, which did pretty well during the recession, are now very much at risk.”
For all the concern in Washington about the cuts, investors are signaling that the economy is strong enough to weather any reductions in spending, with home sales, consumer confidence and employment all rebounding. Economists at FTN Financial said in a report last week that while being characterized as a recession risk, sequestration cuts are less than a third of the size of the tax increases on Jan. 1.
The Standard & Poor’s 500 Index climbed 6.3 percent this year through last week, better than the 4.1 percent gain for the MSCI All Country World Index. Treasuries were becalmed, with yields on 10-year notes ending last week at 1.96 percent, little changed over the last month. The U.S. Dollar Index, which tracks the currency against six of America’s biggest trading partners, was at a five-month high.
Stocks sank today by the most since November, while the euro and Italian bonds erased early gains as election projections spurred concern about prospects for a stable government in Italy. The S&P 500 slumped 1.8 percent to 1,487.85 at the close in New York.
In the U.S., places including Fayetteville, North Carolina, and Los Alamos, New Mexico, will be hurt by the across-the-board cuts almost as much as the Washington, D.C. region, home to defense contractors such as Lockheed Martin Corp., said Vitner. The reductions, known as sequestration, will trim growth by 0.5 percentage point this year and wipe out 350,000 jobs if they take effect March 1 and remain in place through December, according to the median forecast of 26 economists surveyed by Bloomberg last week.
A majority of the economists also said they expect a resolution of the standoff between President Barack Obama and Congress would be reached, with the median forecast of 21 responses predicting a compromise in 30 days. Such an outcome will result in little erosion to growth, the survey showed.
“We will probably see the sequester triggered, but I think we will probably rework it in some fashion over a period of weeks before it has done any real damage,” said Robert DiClemente, chief U.S. economist at Citigroup Inc. in New York.
Congress and Obama agreed to automatic cuts as part of a deal to increase the U.S. debt limit in 2011. The $1.2 trillion in reductions through fiscal year 2021 would be split evenly between defense and non-defense spending. The sequestration, designed to be so draconian that it would push Democrats and Republicans to compromise on taxes and spending, instead has hardened both parties’ positions.
“The sequester is bad macroeconomic policy,” said Alice Rivlin, a senior fellow at the Washington-based Brookings Institution, who previously served as vice chairman of the Federal Reserve Board and budget director for President Bill Clinton. “We don’t need a new shock of this magnitude to the economy when it’s not growing very fast, and it’s a mindless, stupid way to cut the budget.”
Impact on Growth
Sequestration will force the federal government to cut spending by about $56 billion this calendar year, which takes into account the fiscal year ending in September and the first three months of the 2014 budget, according to calculations by economists at JPMorgan Chase & Co. in New York. They estimate that will reduce growth by about 0.4 percentage point even if lawmakers make changes that will minimize the damage, economist Daniel Silver said in a Feb. 21 research note.
States that backed Republican Mitt Romney for president are among the most vulnerable, a comparison of a report by the Pew Center on the States to the 2012 electoral map shows. Federal spending is 5.3 percent of a state’s gross domestic product on average, according to the report. Of 20 states plus the District of Columbia where federal spending accounts for a higher percentage of the GDP, 12 voted for Romney in November.
Yet pro-Obama states might feel a deeper impact, the Pew report shows. The three places where federal spending is nearly 20 percent of GDP -- Virginia, Maryland and the District of Columbia -- favored Obama in 2008 and 2012. New Mexico and Hawaii, two states that rely upon federal spending for more than 10 percent of their GDP, also favored Obama in both elections.
The District of Columbia and neighboring suburbs in Virginia and Maryland “are particularly vulnerable due to the multitude of defense agencies and contractors located in the region,” according to a Feb. 18 report by Wells Fargo’s Vitner and colleague Michael Brown based on the Pew Center’s research.
Washington is the seventh-largest U.S. metropolitan area, with 5.7 million people, 2011 Census Bureau data show. It’s home to Bethesda, Maryland-based Lockheed Martin, the world’s largest defense contractor and maker of the F-35 Joint Strike Fighter, the Pentagon’s costliest weapons program. Northrop Grumman Corp., maker of Global Hawk surveillance drones, and General Dynamics Corp., producer of Abrams tanks, are both based in Falls Church, Virginia.
The pain will spread from Washington to large military bases in small Georgia towns. It would affect many Americans, from air traffic controllers and nuclear-warhead researchers to elementary school students and Internal Revenue Service informants, according to the Pew Charitable Trusts. Even federal workers charged with implementing sequestration face furloughs, Pew said.
Hawaii and Alaska have the most at stake because federal defense spending accounts for a bigger chunk of their economies, according to Wells Fargo. Other states at risk include Kentucky, Alabama, Missouri, Connecticut and Arizona, where military outlays account for at least 5 percent of the economy.
While non-defense federal spending is more evenly spread throughout the country, it accounted for 9.2 percent of New Mexico’s gross domestic product as of 2010 and 4.9 percent of Idaho’s, making them the fourth and fifth areas most likely to be affected, according to Vitner. Non-military outlays accounted for 10 percent of the economies of the District of Columbia, Maryland and Virginia.
New Mexico may be hurt by less spending on nuclear weapons research at the Los Alamos National Laboratory as well as reductions in space exploration, renewable energy and nanotechnology. Georgia towns, such as Columbus, Warner Robbins and Hinesville, near military bases face economic slumps, according to Wells Fargo’s research.
Hinesville, a city of about 35,000 that’s 40 miles southwest of Savannah, is home to the U.S. Army’s Third Infantry Division at Fort Stewart, the largest Army base east of the Mississippi River.
Even military towns that had benefited from the relocation of troops after the last round of base closings may feel the pinch this time, said Vitner. Places such as Fayetteville, North Carolina, home to Fort Bragg, are a prime example, he said.
Kacey Brown, 29, manager at Morgan’s Chop House in Fayetteville, realizes that the cuts could affect the area’s economy, even though the officers and higher-ranked military personnel who make up between 50 percent and 60 percent of the restaurant’s clients may not be as affected as those lower-ranked soldiers or some civilians.
“For the locals around town it will change,” he said. “They won’t be able to go out, do the things they normally do.”
Some areas have already slowed amid the uncertainty caused by the wrangling over the budget.
“It’s been having a big effect for a long time really,” said Kevin Holsapple, executive director of the Los Alamos Commerce and Development Corporation, a nonprofit group that operates the Chamber of Commerce and other economic, community and development activities in the city of about 18,000.
The laboratory has been “very conservative” in their spending and that “wafts through the local economy in a place like this,” he said.
Still, another concern is the damage a protracted battle will do to household sentiment. With Americans already facing higher gasoline prices, the sequestration would deal a new blow to confidence for consumers, whose spending makes up about 70 percent of GDP, said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.
Burden on Consumers
“It’s a very slippery slope,” Sweet said. “Government is going to be a significant drag. That’s going to put the burden on consumers and housing.”
Marriott International Inc., the Bethesda-based operator of Ritz-Carlton and Residence Inn hotels, said Feb. 19 that the cutbacks may hamper travel. The largest publicly traded U.S. hotel chain lowered its outlook for revenue per available room, an industry measure of occupancies and rates.
“Sequestration will be a negative to the travel industry,” Marriott Chief Executive Officer Arne Sorenson said on a Feb. 20 conference call. “How negative? We don’t know.”
“The longer it stays in place, the more that failure of our political process will become a negative to economic growth,” he said.
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