Will the US fall off the

25th June 2012

In this weekend's Telegraph, respected economist Joseph Stiglitz suggested that political intransigence could send the US back into recession as stimulus measures expired and there was insufficient political consensus to decide on what should replace them: "It's unambiguously the case that these measures will slow down growth," said Mr Stiglitz. "If there is European turmoil, there is a significant probability of going into a recession."

David Rosenburg, a US economist with Gluskin Sheff, went one step further, suggesting that the fiscal squeeze at the start of 2013 would cut around four percentage points out of real GDP growth: "There have only been two instances in the past when we experienced such fiscal restraint and recessions ensued both times. It pays to note that with the baseline trend in real GDP little better than 1%, even if half of the expected restraint manages to get kicked down the road, the economy will at best stagnate in 2013."

The reasons behind these problems are dealt with in more detail by Keith Fitzgerald in this Forbes article. He sees three financial cliffs: "First there's the massive adjustment from tax and spending provisions set to expire and/or come into effect near the end of 2012. The former involved Bush era tax cuts that expire on December 31, while the latter involves automatic spending cuts that hit January 1, 2013….Secondly, there's the debt debacle and debate with another $2+ trillion now in the oven…The third factor, he says, is that politicians don't get that issues one and two will hit the economy way before it hits the theoretical limits of expensive capital and debt overhang."

Fitzgerald believes that the consequences will be ugly. The expiring of the Bush era tax cuts will raise taxes for small businesses, making it more difficult for them to hire. Hikes in capital gains tax will act as a disincentive for investors. These two factors will conspire to put less money in the pockets of consumers, thereby dampening spending.

There are signs that the prospect of the fiscal cliff is already having an impact on the economy with companies holding back on spending. Certain parts of the economy are likely to be hit particularly hard by the end of the Bush-era tax cuts, notably defence and medical groups.

However, having created this apocalyptic scenario, Fitzgerald says that the real issue is the possibility of federal government inaction. Certainly none of these problems look impossible to resolve if there is the political will to do so.

This political brinksmanship may ring a familiar note to observers of US politics. Almost exactly a year ago, there was similar intransigence over the US debt ceiling. This went to the wire and, for a brief period it looked as if the US was going to default on its debt. 

This has led many to believe that the outcome will not be as bad as billed. They point out that no politician wants to march the US into a recession and therefore compromise will ultimately be reached.

There are even lobbyist groups that are joining together to ensure that politicians do not risk the economy by playing the same tricks they paid last year: "Wall Street lobbyists are preparing an aggressive campaign to stop the political brinksmanship. "The experience of last year taught everybody to be … focused on it earlier and not assume that this is business as usual," said one bank lobbyist based in Washington."

And even if politicians don't reach a compromise, there are those who believe it may not be as bad as expected: Anyjoe on the Telegraph community boards says: "Yada, Yada, Yada. Of course the US isn't going to be able to resolve their political gridlock even after a Presidential election, they are too divided along too many issues, which is going to be reflected in their economy and even more so in the global economy. But falling off a Fiscal Cliff is too strong a description to describe it.  Maybe the rest of the world might fall off a Cliff but not the US.  The Fed is just going to help continue to kick the can down the road for a little while longer with its printing presses working over time."

There is one final point: Doesn't this look eerily familiar? Isn't this just what has been happening in Europe as governments try to balance the competing needs of deficit reduction and economic expansion? The US has – to date – ‘kicked the can', but at some point it will need to start the painful process of returning to normal business. Policymakers may be able to hold off a fiscal cliff, but they will have to start the gentle roll down the hill at some point.

 

More on Mindful Money:

Whose fault is today's bad economy?

Should central banks be policy makers of last resort?

Could action on tax avoidance trouble small businesses?

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