Fiscal Cliff or Fiscal Slope?

The term fiscal cliff certainly sounds ominous, which is probably exactly how the media, banks, fund managers and other self-interested parties would like. The more money that is floating around the system the better for all. Unfortunately, at some point the the US $16,000,000,000,000 debt should really be repaid; or at least stopped from increasing any more.

Basically, come 1 January 2013 virtually all of the the good citizens of the United States will find themselves with higher personal tax rates courtesy of the expiration of the 2010 Tax Relief Act. At the same time there will be a sharp reduction in government spending, across numerous areas including defence, health-care and unemployment benefits, as a result of the  Budget Control Act of 2011. This double whammy of spending cuts and tax increases is what Ben Bernanke was referring to when he used the term “fiscal cliff” in February 2012.

The Congressional Budget Office produced a report in November which claims the changes to tax and spending policies will reduce US GDP by 0.5 per cent and unemployment will rise to 9.1 per cent in 2013 before economic growth and employment picks up again in 2014. Hardly the stuff of nightmares and exactly why the term “cliff” is inappropriate. The danger to the economy that the tax increases and spending cuts will bring is from the multiplier effects; the proposed $500 billion in tax increases and $200 billion decrease in government spending will adversely affect the US economy by far more than the $700 billion being taken out. This however will take time to be felt and as such “Fiscal Slope” is probably a more appropriate description.

The risk to investors throughout the world is that the fiscal cliff is ingrained terminology and should a deal at Washington not be found before, or soon after, 1 January 2013 then financial markets will probably overreact. Financial markets are skittish at the best of times and this is an unwelcome addition to the myriad of other worldwide problems.

I personally believe this will will sorted, with the maximum possible ineptitude, before it becomes a real problem. Afterall, much better to leave financial problems for the next round of politicians to sort out rather than face the ire of the American public themselves. However, despite most market commentators being bullish on what 2013 will bring, some investors may consider sitting out the next few weeks to see whether the US does start down the “slope”.

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