The Fiscal Cliff

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect.  The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession. 

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.”  Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview.  And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.”  Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.”  Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues. 

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes.  The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not.  So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.

Wealth Enhancement Group

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