What is the U.S. Fiscal Cliff?

The U.S. Presidential election is over, and markets were decisively negative the very next day. Some argued that the decline was owing to the Romney loss – had Mittens taken office next year, his policies would be more business friendly, and hence, good for markets. But immediately the attention turned to the U.S. Fiscal Cliff. After scanning the dial, the chatter about market declines will probably revolve around this new buzzword for the next few months.

So, this Fiscal Cliff thing…

This Fiscal Cliff simply refers to automatic spending cuts and expiring tax cuts (meaning taxes would go up) that would take effect on January 1st, 2013. The dramatic nature of these changes would be akin to Thelma and Louise-ing it, economically speaking.

Increasing taxes and decreasing program spending would remove stimulus from the economy. The reason these automatic measures would occur is because they were a requirement of the deal made between Democrats and Republicans in order to raise the U.S. Debt Ceiling earlier this year. The deal was that a “Supercommittee” of Democrats and Republicans would work together to propose budget measures that would cut the deficit by $1.2 trillion over 10 years. If they couldn’t reach a deal, then these automatic measures, the Fiscal Cliff, would occur.

All of this is due to the now prevalent thought that the US debt was spiralling out of control. They would agree to raise the debt ceiling this time (it happens a lot) as long as they worked hard to control the budget. If they couldn’t come to terms on how to do that, these automatic measures would take force. And these automatic measures were thought to be drastic enough that it would provide an incentive to avoid it from happening.

So far, that hasn’t been the case.

Tangent: The debt ceiling vote is a bit of a farcical endeavour IMHO. When congress passes spending or tax cuts they are effectively approving changes to the budget. By then having a vote to increase the debt ceiling they are then deciding whether or not to fund the commitments they’ve already made.

What could happen if we hit the Fiscal Cliff?

The Congressional Budget Office estimates that the spending cuts and tax increases would reduce the deficit by $560 billion. That is a very significant removal of stimulus. Remember, the Supercommittee are busting their nuts trying to reduce the deficit by $1.2 trillion OVER 10 YEARS. This $560 billion reduction would take place must faster than that.

Analysts expect a 4% drop in US GDP for 2013, roughly 2 million jobs lost, and that a deep recession would result. And with our Southern neighbours being our largest trading partner, that would almost certainly put Canada into a recession as well. So, yes: it’s a big deal.

And here’s another buzzword that will re-rear it’s ugly head: political brinksmanship. Don’t expect any substantial headway to be made anytime soon. I wouldn’t be surprised if this thing reaches a crescendo right around Christmas.

(By the way, their are now 46 days until Christmas.)

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 9 comments
  • Susan Yates

    Well said, Preet. Without being completely cynical, dare I ask why this issue wasn’t a bigger deal in the US election?

    • Preet

      Probably because the two parties were both hoping to control both the House and the Senate so they could push through what they wanted. But with Congress still divided, it’s back to a fiscal stalemate.

  • jay

    Love the new (look) blog,I’ll have to test the archives (2007) before I give you a gold star…

    • Preet

      Thanks Jay!

  • harebell

    It appears that you wish to bleed the US dry for short term gain, knowing that the goose that lays the golden egg will most assuredly die.
    They have to stop spending and pay off their debt. Those who buy the services should pay for what they buy, to do otherwise is madness.
    I understand that folk like you can only exist by preying on others and that you must encourage your victims to continue in their destructive behaviour. But that is not good for those you live off.
    The biggest hypocrites are those who suck at the public teat yet don’t believe in covering the bill themselves. In other words people like you. Folk are waking up and they are starting to realise that some of you are working to destroy our society because you personally will profit in the short term at the expense of the majority.
    The worm is turning folks..

    • Preet

      Do you like gladiator movies?

      • harebell

        Your point being?

      • Kyle Green

        Harebell are you blaming Preet for this madness? Or the US? Who are you referring to?

        On another point, what are YOU doing to stop this?

      • harebell

        I’m not blaming anyone individually, the blame lies with the unchecked capitalist culture that created the ponzi scheme that is the modern financials services industry. Constantly gambling is never good, but gambling and using other folks cash to pay off previous losses is even worse.
        Why can’t we hold the folk who gamble accountable for their errors, rather than bail them out and not gaol them? It’s this failure to take responsibility for ones own mistakes while insisting that others keep giving them more that makes US and UK financial operators seem like the villains.
        It’s time to ask those who took the most to give some back.
        As for me, I keep working and paying taxes so the placemen in government can hand it over to their sponsors and try and tell us it’s for the greater good.