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Tuesday, November 20, 2012

The fiscal cliff

Talk about the fiscal cliff is all the rage these days.  Market pundits will make a big deal out of a "deal" I am sure.  I believe there are three scenarios here.  Let me see if I can simplify things a bit.

1. Nothing happens.  The combination of tax hikes and spending cuts go on as planned.  The economy has a  deep recession and stock markets crash.

2. Some kind of deal happens and there are no spending cuts or tax hikes.  This seems very unlikely given the rhetoric coming out of Washington.  I believe both parties are now convinced something has to be done.  This could be because the ratings agencies are threatening to downgrade the U.S. again if nothing changes.  If these agencies had been doing their job back in the early 80s when we got spend happy, we might not be in the shape we are in today.  If this scenario should happen, the market should have a big bounce before it realizes we are already in a recession and crashes.

3. Some kind of deal is struck between the parties that involves some kind of tax hikes and or spending cuts.  The market rallies on the news, then rolls over and crashes when it realizes any combination of tax  hikes and or spending cuts will only make the recession that we are already in worse.

The only way out of the debt situation we are in is not to get there in the first place.  There is no way a country can live beyond its means for decades without experiencing some pain when the debt finally gets too big.  There are some similarities to FDR's second term going on today.  He went on a spending binge to spark an economic rebound in his first term.  The economy did indeed pick up and the Dow had a massive rally.  The spending drove the debt level way up and after reelection it was decided to cut back.  The economy being artificially pumped up in the first place, crashed again and so did stocks.  Here is a chart from that time period.

The Dow took a 50% haircut in about one years time.  The economy is on fire and the politicians are sitting around in Washington talking about how much and what kind of fuel to throw on that fire.  I don't know how to be any clearer then this.  The economy and the stock market is going to crash over the next year.  If you think otherwise you will be greatly disappointed. 


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