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Wednesday, December 12, 2012

The fiscal cliff

The fiscal cliff came from the Budget Control Act of 2011.  You might recall the market crash last year over the debt ceiling debacle.  This act was a number of tax hikes and spending cuts given to Republicans in Congress in return for raising the debt ceiling.  These tax hikes and spending cuts will definitely be a drag on an already slow economy.  I view this situation as President Obama took a rope, tied a noose in it, and the Republicans willingly stuck their head in it.  He is now tightening the noose.  From what I hear on TV and in talking to people it seems a big majority think there will be some kind of deal.  I am not so sure that will be the case.  To see why, lets try to put ourselves in the president's shoes.  He just won his last election.  Since he will likely never run for any public office ever again, he has a lot of latitude in what he can do.  I wonder what his goals are for his second term in office.  Off the top of my head, I would think he wants to leave office with people thinking he was a good president.  I also believe he would like to give his party a good chance to win the next election.  With those two goals in mind, lets look at the current situation.

We have a slowing global economy.  We might even be in a global recession already.  The U.S. economy is weak enough that any tax hikes and spending cuts are likely to put us in recession even if we are not already there.  If the president negotiates any tax hikes or spending cuts that then send us into recession he will at least be partly at fault.  The media has made it clear to the masses that if we go over the fiscal cliff we will go into recession.  They have also made it clear the fiscal cliff is the Republican's "fault".  From what I can gather in talking to people this seems to be pretty widely accepted.  Here are the possible outcomes from this situation as I see it.

1. Both parties agree that no spending cuts or tax hikes should happen.  I have not heard this even as an option so far.  The ratings agencies have already said they will lower our credit rating if we don't do something.  We could get downgraded and the economy could still go into recession.  That would be the worst possible thing for the president's reputation and his party.  This seems very unlikely.

2. Both parties agree to some set of tax hikes and spending cuts that are different from what is currently scheduled to happen.  The president has talked quite a bit about not letting the tax hikes on the middle class go into effect.  If a deal is made and we still have a recession the president will be held at least partially responsible.  This would likely tarnish both his reputation and his party.  Is there any incentive to go this route?  It seems unlikely to me there is some combination of spending cuts and/or tax hikes that do not negatively affect the economy and greatly increase the risk of recession.  What is the benefit to the Democrats to take that risk if the majority of the people are blaming the Republicans now?  Speaker Boehner is constantly saying they need more details from the president.  Are the Democrats really negotiating or just trying to appear that they are?  I am afraid that I can't really tell and I can see clear reasons why they would not want a new deal.

3. The fiscal cliff goes into affect as scheduled.  The economy goes into recession, but the president blames the Republicans.  People will likely buy this and his reputation will not be tarnished much if at all.  The recession should happen in his first two years in office and we should be into the next recovery by the election time.  That could be viewed positively for engineering another recovery from a mess the Republicans created.  It could also help his party.  I see no down side here for the president himself.  We are likely going to have a recession, why not blame it on someone else if you can.

I am not at all sure it is a slam dunk there will be a deal.  It looks more advantageous to me for both the president and his party not to deal, but give the appearance they are trying to deal.  I think they will be more then happy to hold the rope with the noose in it though.  With a clear majority of people expecting a deal, no deal could be pretty negative for the markets.   I will be looking for signs the president is really trying to negotiate a deal.  So far it seems like he is holding a hard line including completely lifting the debt ceiling that it seems unlikely the Republicans will ever agree to.

If I was a Republican strategist I believe I would say to the president we will do it your way.  Send us a bill and we will pass it.  That would shift the responsibility to the president and the Democrats and would likely throw them into a panic, LOL.


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