Congress on both sides of the aisle is playing a game of political chicken with the debt ceiling; but what would impact mean for the markets and the economy in general?

Although the U.S. hit its $14.3 trillion debt ceiling on Monday, May 16, economic Armageddon hasn’t yet rained down on the U.S. economy. Thanks to some slick Treasury Department maneuvering, the date when the U.S. really reaches the limit has been pushed to around August 2.

But instead of breathing a sigh of relief and resolving to engage in a bipartisan effort to resolve the debt ceiling issue in advance of the August drop-dead date, both sides are likely to wait until the last moment to avoid impact—threatening our fragile economic recovery in the process.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of U.S. debt in Advisor’s Journal, see Storm Clouds over U.S. Debt (CC 11-85).

Why is this Topic Important to Wealth Managers? This topic discusses the Recovery Act spending and its effects on the national economy.  It provides wealth managers with indicators and information to help clients better understand the use of government (taxpayer) funds and their allocation as a result of the financial crisis and ensuing financial recovery.

The American Recovery and Reinvestment Act of 2009, enacted February 2009,[1] was designed to put Americans back to work and combat the largest downturn in the economy since the Great Depression.  Through the Recovery Act, Congress allocated funds in three ways.  The single largest part of the Act —more than one-third of it, or $288 billion— was tax cuts.  Ninety-five percent of taxpayers have seen taxes go down as a result of the Act. [2]

The second-largest part or $244 billion — just under a third — was direct relief to state governments and individuals. This funding helped state governments avoid laying off teachers, firefighters and police officers and prevented states’ budget gaps from growing wider. On an individual level, the Act ensured those hardest hit by the recession received extended unemployment insurance, health coverage, and food assistance.

The remaining third or $275 billion of the Recovery Act financed the largest investment in roads since the creation of the Interstate Highway system; construction projects at military bases, ports, bridges and tunnels; overdue Superfund cleanups; clean energy projects; improvements in outdated rural water systems; upgrades to overburdened mass transit and rail systems; and much more.

The $787 billion (in total) economic Recovery plan included provisions, in sum, designed to (1) create and save jobs, (2) spur economic activity and invest in long-term economic growth, and (3) foster unprecedented levels of accountability and transparency in government spending.

The Recovery Act was intended to provide a short-term jump start to the economy, but many of the projects funded by Recovery money, especially infrastructure improvements, are expected to benefit economic growth for many years. Thus, the Recovery Act’s longer-term economic investment goals include:

• Initiating a process to computerize health records to reduce medical errors and save on health-care costs
• Investing in the domestic renewable energy industry
• Weatherizing 75 percent of federal buildings and more than one million homes
• Increasing college affordability for seven million students by funding a shortfall in Pell Grants, raising the maximum grant level by $500, and providing a higher education tax cut to nearly four million students
• Cutting taxes for 129 million working households by providing an $800 “Making Work Pay” tax credit
• Expanding the Child Tax Credit [3]

Has the Recovery Act worked?

When the Recovery Act passed, the economy was in “freefall”.  In the fourth quarter of 2008, real gross domestic product plummeted by an annual rate of 6.8 percent. In the first quarter of 2009, the economy lost more than 2 million jobs. The ranks of the unemployed were increasing and the speed of job loss was also accelerating.

Since the passage of the Recovery Act, indicators show this trend has turned around. Two years ago, the country was losing 780,000 jobs per month; now, the government states that the private sector has added jobs for 11 straight months, for a total of more than a million new jobs in 2010.

The trend in GDP growth shows a similar reversal after the passage of the Recovery Act.  GDP was contracting at a rapid pace in late 2008—its fastest rate in decades—but it experienced a sharp turnaround following the passage of Recovery Act, leading to six quarters of growth.  Whether this current growth correlates to the tax relief and spending provided by the Recovery Act, or a part of it, will be debated through the 2012 election cycle.

Tomorrow’s blogticle will continue to discuss new and exciting planning aspects of 2011.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts

[2] See generally “A New Way of Doing Business: How the Recovery Act is Leading the Way to 21^st Century Government.”  February 2011. http://www.whitehouse.gov/sites/default/files/new_way_of_doing_business.pdf. Last Accessed 2/28/2011.

[3] The Recovery Act”. http://www.recovery.gov/About/Pages/The_Act.aspx. Last Accessed 2/28/2011.

Tectonic forces are pulling the U.S. economy in opposing directions: Republicans, who won the House and a majority of state governor seats in November elections, promise to cut spending and taxes and rein in government excess. But following the Republican victory, the Federal Reserve is launching a fresh round of its own brand of stimulus, announcing a plan to purchase $600 billion in Treasury securities. Will the forces of Congressional fiscal policy and Fed monetary policy remedy the sluggish economy, or will they stress it beyond repair?

The Fed purchase is intended to raise the price of Treasuries, which should lower long-term interest rates and provide banks with cash to lend to their customers. The expectation is that lower long-term rates will encourage home refi’s and boost corporate investments and expansion, which, it is hoped, will created new jobs.  But there is no guarantee that banks will lend from any cash infusion resulting from the Fed purchase. Banks could choose, instead, to increase their cash reserves against expected defaults. And U.S. corporations are not showing any signs of going on a hiring spree—instead, they are sitting on record amounts of cash.  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

We invite your questions and comments by posting them below, or by calling the Panel of Experts.