Much has been written about the sequester, in which up to $85 billion of government spending will be cut this year, as part of an overall deficit reduction programme that envisages cutting over $1.2 trillion in the course of the next decade. The impact on US domestic politics may well be dire, with government programmes to protect poorer children and the elderly on the block; scientific research capable of coming to a standstill; and public health inspections due to be reduced significantly. The vast majority of the cuts will be on defence spending, almost half, though the US military is so overfunded at the moment it might be able to absorb this without blinking. However, the overall macroeconomic impact may be minimal. At worst, according to Standard & Poor's, it may trim US economic growth this year by a percentage point. Many market participants have shrugged off the problem, and Warren Buffett has said that the US is "a strong country that will overcome whatever 535 people [in Congress] do".
While the overall effect on the recovery might be minimal, the sequester might prolong the pain for lower-income Americans, particularly those who are going through a long spell of unemployment. That's where the second problem comes in �" for the US Federal Reserve launched the third round of quantitative easing (QE) last year as an open-ended exercise that would buy $40 billion worth of bonds, including mortgage-backed securities, a month till such time as unemployment dipped below 6.5 per cent. This is an extraordinary expansion of the Fed's balance sheet, in which it essentially takes dicey real estate securities off banks' hands in order to reduce the risk in the market. At a combative Senate hearing last week, Federal Reserve Governor Ben Bernanke insisted that the benefits from QE3, as it is called, continue to outweigh the costs. Also released last week, however, were the minutes of the January meeting of the Fed's top policy-making body, the Federal Open Market Committee, in which many participants apparently argued that the costs and risks of QE3 were so great that it would have to be terminated before its labour market criteria are met. If the effects of the sequester on lower-income Americans are harsh enough, those arguments will be easier to oppose.
Exiting QE will not be easy; it will have to be done gently, as selling off too many purchased assets at one go will send interest rates up, and endanger the global recovery. But it cannot be delayed too long either; asset bubbles have begun to build up across the world, and various advanced country central banks are relaunching their own QE programmes to increase their competitiveness, in a manner that economist Nouriel Roubini has pointed out mirrors currency wars. But QE has enabled an appetite for risk that has pushed capital flows towards India, a crucial part of financing this country's widening current account deficit. For India, the timing of QE's end is vitally important; it will have to get its domestic house in order well before global risk appetite dries up.