The real fiscal cliff has nothing to do with the $1 trillion in "defense cuts" and "tax increases" due to take place on January 1, 2013.
The real fiscal cliff is growth.
The reason our government is paying almost nothing to borrow money right now is that there aren't good alternatives. Everything else looks risky. Lending to other governments looks risky. Lending to people buying homes looks risky. Lending to corporations that might go bust, also risky.
So let's assume we're all about to be made happy, with faster growth, and lower unemployment starting to push up wages. What happens, then, to the government's costs for borrowing new money?
It goes up. And small increases in interest rates make for a big change in costs, when calculated as a percentage. It's simple math. If you go from 1% to 2%, that's an increase of 100%. Your short-term cost for borrowing $100 just went from $1 per year to $2 per year. And then what about 3%?
That's what happened to Spain and Italy. Because we have yet to set up a payment plan for the last decade's wars, because we borrowed money for tax cuts that didn't pay off in higher revenue, we're stuck with trillions of dollars of extra debt, plus debt on that debt. The fiscal impact of the 2009 stimulus has all but worn off. The last decade's debt is the elephant in the room.
The so-called "fiscal cliff" only makes a small down payment on this $16 trillion in debt. It doesn't even, by itself, take care of the current accounts deficit. Ending the Bush-era tax cuts could make a bigger dent in that deficit, but as all critics of both policies will point out, either going off the cliff or raising taxes will, in the short run, kill the recovery.
It doesn't matter how you do it. Raise revenues, reduce spending, it's all fiscal drag.
My view is that we should decide, now, whose ox gets gored when the economic recovery takes hold.
My view is this: A carbon tax, earmarked for paying back war debt, would encourage the most important renewable energy of all, efficiency. A financial transaction tax, aimed at paying back the debt lost to earlier tax cuts, would fall hardest on those who benefited the most from those cuts. And if we could close global tax havens, by treaty, we'd be using our military for something profitable.
But here's the truth. The debt overhang of the last decade is going to put a tax on growth as far out as we can see. The faster we grow, the higher the tax on growth gets, because the higher ongoing government interest rates go. And slow growth, as we're experiencing now, just leads people to try and "kick the can down the road" by refusing to take even modest steps toward fiscal sanity.
Inflation isn't an answer, either. Inflation raises interest rates without even offering organic growth. Inflation can work, but at the cost of destroying savings and destroying the credibility of the currency. It's like any drug -- a little can ameliorate the pain, but too much means a greater pain down the road.
Paying for the mistakes of the past is the task before us. That means slower growth and more fiscal pain for a long time to come. The faster we grow organically, the harder we have to hit the fiscal brakes on that growth in order to keep our ongoing borrowing costs from exploding.
No matter how you seek to deal with the problem, either with cutting spending on the military, throwing grandma from the train, or raising taxes on any segment of the population, you're taking money out of the economy, and cutting back on growth. It's a fiscal brake that will be applied for the next decade. The air has to be let out of that balloon gently, slowly, with a long-term plan that adjusts cutbacks to growth automatically.
The next government that can put a long-term plan in place and stick to it, from any party or political movement, will be the first. That's why it's so vital to build a political consensus around the reality of the problem before taking any steps to deal with it.
Just remember: The real fiscal cliff is economic growth. It's only when we start to grow that the crisis will hit.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.