A cliff is not a barrier --- it's the complete lack of a barrier. A cliff allows you to drive over the edge and plunge into the abyss.
This image fits our country's current economic predicament. The economic effects of hitting the so-called "Fiscal Cliff" could plunge us into another major recession in the first half of 2013.
What exactly is the Fiscal Cliff? Essentially, it's the result of a combination of predictable economic events: expiration of the Bush tax cuts as well as the elimination of the extension of unemployment insurance and finally the expiration of the 2% payroll tax relief. There are also numerous federal spending cuts mandated --- primarily in Defense budgets. These events are all predictable, because under current law, they are timed to occur in January 2013.
According to the CBO these events will provide a combined total of $607 billion in savings and revenues to the US government. After adjusting for the economic drag, these tax increases and spending cuts would cause, the net savings would come to an estimated $560 billion.
The CBO goes on to say that, as a result of driving over the cliff, America would have negative GDP growth of -1.3% in the first and second quarter of 2013. According to the National Bureau of Economic Research, such an outcome fits the definition of a recession.( Two consecutive negative quarters of GDP) The NBER projects a +.5% growth in GDP for the year. If that figure is correct, the second half would have to grow by something greater than 2%. This would also cause slower growth in GDP for many years to follow.
At present, America's debt as a percent of GDP is at 70%. That is the highest it has been since 1950. If we allowed the tax cuts to expire and implemented the spending cuts, this number would fall to the low 60s by 2022. Is that good news? For the long term, it would be a start in getting our debt under control. It would cause some pain and definitely slow even more an already anemic economy. It would certainly cause an increase in unemployment in the near term.
On the other hand, if we can just kick the can down the road a piece --- extend the tax cuts and promise to fix it all, sometime in the future --- just like our spineless elected officials have chosen to do time and time again, well, then the total GDP for 2013 would be around 4.4%. There would be 2 million new jobs created. Congress and the White House would be loved by the masses.
But there's a real downside to kicking the can down the road that way: the ratio of debt to GDP would grow to 95% by 2022. That number would be very close to Italy (121%) and above Spain (69.3%) and we know what is happening in these two countries. The interest owed on the national debt would be devastating. It would rise sharply, for two reasons: first, because the total debt would be increasing, and second, because those buying our debt would demand higher rates. They would be entitled to those higher rates, because of the increased risk of owning US Treasuries.
This situation would eventually cause higher taxes and significant cuts in spending. Some estimates say that by 2022, two out of every 3 dollars going to Washington will be spent on some type of legacy benefit. (Medicare, Social Security, Welfare and Pensions) This would leave 1 dollar to fund Defense, all other Agencies, as well as servicing the enormous debt. Medicare and Social Security would have to be part of the spending cuts, regardless of what happens, due to the increase in the retired population.
These numbers are not mine --- they come from the Congressional Budget Office, so these are Congress's own numbers. The numbers assume a stable environment in Europe and China. They could be considerably worse.
I have tried so far to frame up what is at stake in January 2013. As much as this Fiscal Cliff has been talked about, it helps to put a little substance to it. And oh, by the way, the average middle class taxpayer will owe $3000 in additional taxes if tax cuts expire.
Corporate America is already battening down the hatches by curtailing spending and hiring until they have some idea what Congress will do about this looming deadline. Sam Zell just predicted a recession. And Zell went on to say that, because of lack of leadership in Washington, Corporate America is keeping 2 trillion dollars of capital on the sidelines that otherwise would be deployed in employment and other capital investments.
The Cliff came about partly because of a bargain reached between the Congress and the White House, an agreement to increase the national debt ceiling. The deal was, either fix the problem or the axe will fall. Well guess what? Our spineless elected officials elected to kick that can down the road one more time.
They delayed a decision until the lame duck session of Congress. That gives them less than 60 days to fix our long term deficit woes or allow the tax increases and spending cuts to do it for us, at least partially anyway.
Now for a little history lesson. Do you know how many commissions have been set up to study the US debt crisis? Several, of which the most recent is the one commissioned by the President in 2011 and known as Simpson-Bowles. These were all non partisan commissions. And every single one of them arrived at the same conclusion --- if we don't curtail our spending, we are going broke.
Do you know how many of the recommended plans were enacted? NONE. We have had many chances to fix things, but our elected officials had no guts; they were living in fear of not being re-elected.
Will they fix it this time? Probably not. The President and Senator Harry Reid say "No deal . . . unless it has higher tax rates on the wealthiest Americans." Meanwhile, Speaker of the House John Boehner is being pulled around by the short hairs by 50 or so Tea Party types in the House. The Tea Partiers insist on no tax increases of any kind.
Think I'm exaggerating? Remember, the last continuing resolution was held up by the House for this very reason. Our debt was downgraded, because we would not approve a debt increase. No, folks, the only thing I expect at "the Congressional Corral" is a shoot-out --- widely covered on TV, of course, with plenty of media opportunities for individual members who enjoy posturing for their "niche" constituencies.
Our heroic Congress is willing to engage in such a shootout . . . provided each Congressional cowboy gets his 15 minutes in the media spotlight.
They'll stare at that can in the road. They'll analyze it and draw a bead on it. Then they'll kick it down the road, walk away, and declare everything's gonna be OK.
Bill Gross said it best in his newsletter: The US is a Debt Addict Hooked on "Budgetary Crystal Meth." Ouch! You know we can do something about this by going to the polls and voting for candidates that aren't afraid to tell the American people the truth and the guts to do something about it. The longer we put it off the harder the pain will be. Let's get out on Nov 6thand do our part.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.