The Cliff Revisited

Friends, we are NOT going off the fiscal cliff.  Bank on it.

Now, let me just say that the consequences of doing so would not be so dire as the mainstream media would have you believe.  The Congressional Budget Office (CBO) has estimated that heading over the precipice would subtract 2.9% from GDP in 2013.  The latest Bloomberg consensus forecast pegs GDP growth for 2013 at 2.0%, so that would mean negative GDP of 0.9% - a recession, but the mildest in post-WWII history.  For perspective, the trough of the last recession was at -8.9% GDP.

Granted, the expiry of the Bush tax cuts for all Americans would crimp spending.  But spending's lackluster right now anyway - retailers are forecasting such a ho-hum holiday shopping season that they're turning Thanksgiving into Black Thursday by opening at 7 or 8 pm, barely giving Mom time to clear away the turkey leftovers.  Analysis by SL Advisors posted on Seeking Alpha estimates that this would detract 1.3% from GDP.

But the media would have you believe that we'd face the Mother of All Recessions, an economic Armageddon that would throw us back into the Stone Age.  And that hue and cry alone will spur the pols to come up with some compromise, kicking the debt can down the road a la Greece.

SL Advisors predict that the compromise will include a return to pre-Bush tax rates on the "rich," however we define them - joint incomes over $250-500k, somewhere in that range.  The CBO estimates that will result in a 0.1% drag on GDP growth (the rich spend pretty much the same regardless of the economic climate or the tax environment).  They also predict that the Obama reduction in the FICA tax and emergency jobless bennies will be allowed to lapse, as neither party has expressed much interest in continuing them (good news for Social Security, as it's already bankrupt).  That will produce a 0.8% drag on GDP according to the CBO, because it affects more people (ie, it's not "progressive").

So we're going to see a hit of nearly 1% to GDP anyway, and it's going to come on the revenue side.  The mandated spending cuts?  They'll be minimal.  The 0.4% automatic defense cuts won't happen, and the automatic cuts of the same magnitude in non-defense discretionary spending will be reduced and deferred long into the future (read: after the next election).

So the bottom line is that Washington will remain the media's lap dog and forge some compromise that will increase debt, maintain spending, and soak the rich, and the result will be another year of lackluster output growth.

And guess what?  We'll wind up in recession anyway - not because of the cliff, but because of other headwinds, including Europe, which Nouriel Roubini - who called the housing bust and the last recession - predicts will spread from the EU's periphery to its core.  Europe is already in recession, and that means that Bloomberg consensus forecast for 2013 US GDP is already too rosy.

SL Advisors go on to say this:  "Under different circumstances during these negotiations the President and Congressional leaders would be maintaining a watchful eye on the bond market for its approval of fiscal discipline, and to a lesser degree the rating agencies.  Except that, as a barometer of such things the bond market no longer works.  The Federal Reserve is by far the biggest buyer of bonds and since they're not economically motivated interest rates won't be allowed to respond by voting on the outcome."

But again, it's not the bond market that'll drive policy.  It's headlines like this one: "The Economy (Probably) Can't Survive a Short Dive Into Austerity Crisis."  "Can't survive?"  Really?  Ah, sensationalism - thy name is Legion.

A Washington Post headline recently screamed that "2 million could lose unemployment benefits unless Congress extends program."  The article notes that "many jobless Americans have come to depend on the benefits."  And there's the answer to the question of whether the benefits should be extended.