In Part 1, we explored what the fiscal cliff is. In a nutshell, it’s a bunch of tax increases and spending cuts that could have a very sharp impact on people, businesses, and the economy as a whole. If the government fails to take action, the fiscal cliff will hit. It is an entirely self-inflicted wound because all of this was put in place by the government.
Here is a brief update and a look at how I think it will play out.
To the surprise of very few, none of the presidential candidates are really talking about this. None of the politicians are and neither is the media (aside from the business/economic/market media), even though people and businesses are starting to freak out about it. In essence, there really isn’t much of an update from before. The only thing worth noting is that we got some weak economic numbers over the past couple weeks and the Federal Reserve engaged in a bigger (but likely equally ineffective) round of Quantitative Easing.
I’m hoping the candidates will be forced to address this at one of the debates. We have a debate coming this week, so I have hope. I doubt they’ll give much in the way of useful answers, but I think they will at least address it. The reality is this is starting to show up in the economy. People and businesses are starting to plan their budgets for next year. This is a tremendous source of uncertainty, much more so than usual.
On a side note, to those who say that uncertainty is part of the normal business environment, I agree. However, stop saying that this degree of uncertainty is somehow normal and/or acceptable. It’s a flawed line of thinking I hear far too often and, frankly, I’m tired of hearing it. The Federal Reserve Bank of San Francisco recently put out a paper estimating that uncertainty has increased unemployment by 1-2%, so what we have now as 8-9% would be 6-7% with a more stable tax and regulatory landscape. I think their method here is sound. It’s better than anything I’ve come up with so far to quantify economic uncertainty. I think it’s hard to say uncertainty is a moot point after reading this five-page paper.
Back to the fiscal cliff. When looking at how this could play out, we need to focus on the results of the election because we know the government’s putting off everything they possibly can until after the election. We also need to focus on how the economy does in the next couple months because it is clearly weakening lately. Lastly, we have to consider where the debt ceiling situation is at and whether the government has been able to handle it, either by keeping us under it or raising it.
In the shorter term, regardless the election and economy, I expect a brief, temporary extension of everything. I’m thinking three months or so here, similar to what they did with the Social Security tax to end 2011 and start 2012. It could be as high as six months, in my opinion. This would set a deadline for the end of March (or as late as June) to come up with something. This is my way of saying that we shouldn’t expect this to be truly resolved this year and we’ll be dealing with this well into 2013. I simply cannot envision them voting to dodge the entire fiscal cliff this year by abolishing the law and extending all tax rates. The uncertainty grows and drags on.
After the extension is when things will really get interesting and this is when it will matter who wins in November. What will also matter is whether the economy continues to slow down as it has in recent months. I don’t see any value in exploring potential scenarios beyond an extension until we see how the economy handles the last quarter of 2012, we see how the election pans out, and we see how effectively the government handles the debt ceiling (or not). There are just too many moving parts right now. As I said before, we’ll be revisiting this.
Links:
Federal Reserve Uncertainty Paper: http://www.frbsf.org/publications/economics/letter/2012/el2012-28.html
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