The Economic World is Not Flat

The number one topic keeping the U.S. government up at night is the so called, “fiscal cliff”. This is a combination of income tax rate increases and spending reductions that were agreed upon in order to motivate Congress to come closer to balancing the national budget. The original reduction of taxes and increases in spending were organized to temporarily stimulate the economy during the Great Recession. That job has been accomplished and now it is time to return to the original plan. It appears that the desire to return to the original plan is troublesome and everyone wants to renegotiate the deal. One side only wants to have higher taxes on a selected group, “wealthy”, while not implementing the previously agreed spending reductions. The other side wishes to keep the spending reductions intact while modifying the income tax increases through a different mechanism. If you read the details and follow the speeches it sounds like a fierce disagreement about fiscal policy that has strong implications to our nation’s economy. It sounds like experts are gathering together to debate over the best way to continue with economic growth because if we do not avoid the “cliff” we are headed for financial Armageddon and eventually the end of the world as we know it. Is that true?

In reality, I believe we are talking about re-election prospects. In economic terms the cliff is about a $200bn hit to the economy if the agreement is left “as is” which equals a negative 1.4% reduction in GDP in 2013. This is the difference between the original agreement and what is being proposed as a modification. Now that will without question slow down the economy and most likely put the country in a wait-and-see position, not a recession. It is a far cry from the end and smells like fear mongering. The interesting facts are in the three years that follow: 2014 through 2017. In 2014 the economy is back on a growth path with a positive $50bn contribution, then in 2016 a positive $125bn, and in 2017 a positive $400bn. If Congress were looking long term, which is what I think they are supposed to do in their job, the long term benefits are overwhelming for us to return to the original deal.

The real story is that the current discussion is an attempt to avoid the drop in economic activity in 2013 and a slower 2014 because that is an election year. We just finished with an election in 2012 and the next big one is in 2014. Since candidates start campaigning in late 2013 for the 2014 election, they would be campaigning right in the middle of the “decline”. The probability of getting reelected in the decline is not good. Would not all classes, lower, middle and upper, benefit from a long range view by improving the budget debt balance and generating long term economic growth? I am not saying it is not without some discomfort. A reduction of $200bn in economic spending is not wonderful. However, is it not better than slowly slipping into a debt spiral that has taken most of Europe down; think of the repercussions of financial mismanagement? If we continue down the path of always avoiding the budget deficit and hoping some solution magically appears, the final cliff will be more like a free fall into a bottomless pit. When credit markets stop it usually is not a smooth, gradual slow down. It is more like a sudden brake screeching slam into a brick wall.

We are headed down a path where all classes (everyone) will suffer, so why not have all classes (everyone) help right now?

By | 2012-11-27T07:21:29+00:00 November 27th, 2012|Categories: Money Basics|0 Comments

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