Immediate Implications Of The Fiscal Cliff

Our fiscal problems are monumental, and it now appears the government may not be able to steady the ship by January 1st. We will certainly see some progress and we may even avoid going over the so-called fiscal cliff, but solutions we see by January 1 may only be temporary and largely cosmetic. At the moment it appears as though Republicans in the House want to go over the cliff, at least on the revenue side. That allows them to come back early in January and create tax cuts for a sizable proportion of the lower income tax payers, but they may never duplicate the opportunity they have now to put things right. Nevertheless, they will try to create a reasonable tax plan after the first of the year, after Mr. Boehner has been re-elected Speaker of the House, when the new Congress is sworn in.

It’s unclear what will happen with the expenditure part of the budget. If we go over the cliff without any action to deal with that, then rapid action of a general nature will be needed essentially amounting to postponing the significant cuts that would otherwise go into effect immediately. If something quick is not done, there will be a massive negative reaction from the markets, and the economy may go down hill from there. Whatever happens we can almost be assured that there will be no long term solution or restoration of confidence that we have made some hard decisions and are now headed in the right direction.

The FED (Federal Reserve Bank) is running out of tools with which to try to stabilize the economy. In particular, it cannot buy bonds forever in its so-called Quantitative Easing Program, which in the long run could create a significant period of inflation or even hyperinflation. The long term plan based on the best compromise that can be crafted by the Congress must be enacted soon, and certainly no later than in the early part of the new term. Businesses have largely recovered for the crash of 2007-8. They are sitting on 4-5 trillion in accumulated profits waiting to invest it in jobs whenever they get a signal from the Congress that it is serious about a plan to meet our fiscal responsibilities.

The plan cannot leave expenditures as they are, but at the same time cannot cut them at the level set in the fiscal cliff. The same is true of the new tax structure that would go into effect if we go over the fiscal cliff. However, January 1 is not a magical date, even though it may seem that way from all reports. Adjustments could be made in new laws several months into the year by the new Congress and be made retroactive back to January 1. But it this is not done quickly, we’ll be in the midst of a new economic downturn which will only get worse month by month. If decisions are not taken and clearly communicated by March or April, it may be too late to avoid a significant collapse from which it will be very hard to extricate ourselves.

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