Wednesday, January 4, 2012

Will U.S. Economy Suffer Hangover From Boost Provided By Expiring Business Tax Credits

The buzz provided by drinking too much alcohol leads to a nasty hangover. Similarly, providing the economy with artificial stimulus leads to a hangover once the stimulus is removed. The strong performance of the U.S. economy during December may in part be due to a rush to take advantage of expiring business taxes.  According to The Institute for Supply Management,  "Manufacturing is finishing out the year on a positive note, with new orders, production and employment all growing in December at faster rates than in November, and with an optimistic view toward the beginning of 2012 as reflected by the panel in this month's survey".

As pointed out by Mike "Mish" Shedlock, "Expiring tax incentives provided a nice, but unsustainable pop in manufacturing. Notice how prices and backlog of orders did not follow. Regardless of how much tax credits affected the ISM numbers, the global slowdown will take a toll on US manufacturing".

Here are three examples of artificial stimulus leading to a nasty hangover:
1) Y2K - Business and government may have spent as much as $100 billion in upgrading hardware and software to avoid problems from the turning of the calendar to the double zero year. Slowing technologies sales was a key factor in the dot-com bubble popping.
2) Cash for Clunkers - Following the August expiration,September’s new car sales were only 746,000 units, compared to 965,000 a year earlier.
3) New Home Buyers Tax Credit - After the June expiration of the credit worth up to $8,000, sales of existing houses plunged by a record 27 percent in July

Do not read too much into the strong December performance of the manufacturing sector. The hangover may result in weakening January results. Also, the slowdown in Europe will ;provide additional headwinds.

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