Fiscal cliff

[a_majoor]

Hope for the best, but prepare for the worst. An outline of scenarios if/when the cliff is crossed. For real optomists you could start looking to when Social Security or Medicare goes into technical default (perhaps as early as 2016). The predicted unemployment figure is quite low, suggesting they are using the BLS figure rather than U3 (which counts all unemployed).

http://business.financialpost.com/2012/12/13/heres-the-fiscal-cliff-nightmare-scenario/

Here’s the fiscal cliff nightmare scenario

Mamta Badkar and Max Nisen, Business Insider | Dec 13, 2012 11:35 AM ET

With the deadline for the fiscal cliff only weeks away, talks are under way and going nowhere Capitol Hill.

The CBO estimates that if all the tax and spending changes were to take place the economy could fall into a recession and send unemployment up to 9.1%.

But some analysts believe the impact could be a lot worse.

We drew on reports from Wall Street’s top analysts to see what the worst case scenario means for the U.S. economy, stocks, and commodities.

First, what is the fiscal cliff?

The fiscal cliff refers to a number of different policies that are set to change around the same time, most on January 1, 2013.

    The 2001 and 2003 tax cuts that are set to expire.
    The Alternative Minimum Tax (AMT) will hit more people.
    Payroll taxes will increase by about US$120-billion in 2013 if the tax cuts expire.
    The sequester will slash defense spending.
    Unemployment benefits are set to run out which could cut payments by about US$34-billion in CY2013 (calendar year).
    The debt limit will also be reached again around the same time.
    And there are other miscellaneous issues like “doc fix” and “tax enders” that need to be resolved.

Source: Goldman Sachs
The CBO projects a recession in 2013 and a rise in the unemployment rate to 9.1%

    The total of all spending reductions and tax increases would amount to a US$607-billion.
    If all the tax changes and spending policies scheduled to take effect in January 2013, real GDP will drop by 0.5% in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013). Growth would however pick up later in the year.
    The recession will cause unemployment to rise to 9.1 percent.

Source: CBO
BofA economists think short of a full cliff, in their large scenario there will be US$400-billion austerity with 2.5% hit on GDP

    In the event of a full cliff BofA sees US$720-billion of austerity with a 4.6% drag on GDP.
    But in their large cliff scenario, they see US$400-billion of austerity and a 2.5% drag on GDP.
    The fiscal cliff will create two shocks to the economy: the uncertainty shock and the post-cliff austerity shock.
    There are also three scenarios to a fiscal cliff resolution. A fix before year end, a multi-stage fix, and a retroactive fix. BofA analysts think the multi-stage fix is most likely  and expect fiscal conservatives to delay most of the cliff for two or three months, for modest amount of austerity. And that it will take three attempts to resolve all the elements of the cliff by April.

Source: Bank of America
Morgan Stanley goes even higher, saying that the impact could be as high as 5% of GDP

    Morgan Stanley projects that the actual impact of the fiscal cliff could reach 5% of GDP. This is higher than the CBO estimate because the CBO fails to account for the full impact of the payroll tax extension
    Further, using a fiscal year comparison (October to September) as the CBO does underestimates the impact, as most of the cliff would occur on January 1st, 2013.
    The last equivalent fiscal event occurred in 1968/1969 under Lyndon B Johnson. It was a fiscal tightening of approximately 3.75%. The country went from 5% GDP growth in most of 1968 and early 2009 to a recession by the end of 1969.

Source: Morgan Stanley
UBS sees a 12% chance that the U.S. will go over the fiscal cliff and in the following slides they explain what the worst-case-scenario means for the financial markets

    In the event of a full fiscal cliff, GDP would contract 2% “concentrated in the first half of the year,” worse than CBO estimates.
    Their most likely scenario is a ‘fiscal pothole’ in which Congress comes around to a grand bargain. This includes deficit cuts of US$4-trillion or more over 10 years.
    “By ‘fiscal pothole’, we refer to either letting some measures – payroll tax cuts and emergency unemployment benefits – permanently expire (mini cliff), or letting many measures expire only temporarily (temporary cliff).

Source: UBS
The S&P could fall to 1,000

    In the event of a full fiscal cliff, UBS expects severe double-digit losses for U.S. and cyclical non-U.S. equities.
    Valuation multiples tend to decline with earnings possibly to 11-12x.
    Should all of this come to pass, the S&P would be expected to trade at 1,000-1,100.
    In the event of a ‘fiscal pothole’ with a grand bargain, UBS’ most likely scenario, the equity market would face a temporary setback in late 2012 and early 2013, followed by a “range-bound market”.

Source: UBS
Demand for the U.S. dollar will spike

If the fiscal cliff hits with its full impact, the dollar would likely appreciate significantly due to:

    Increased demand from a “flight to quality” associated with recessions.
    A decrease in the private savings rate.
    Decreased demand for foreign goods, particularly oil.

Source: UBS

Energy and base metals would be hit hardest

    In the event of a fiscal cliff there will be severe double digit declines for broad commodity indices and energy and base metals will be most affected.
    Energy would be particularly hard hit. FY 2013 US oil demand would contract by.35 million barrels per day as opposed to growing by 0.15 mbpd in the base case.
    This would send WTI down to $55/bbl and Brent to $67/bbl.Source: UBS

Then of course there’s the ultra-nightmare risk of the debt ceiling not being raised, and the US going into technical default.

UBS

    In the event of a recession or severe U.S. economic contraction, we would likely see a pronounced flight to quality, particularly to U.S. Treasuries. This would push those rates down, and widen credit spreads, pressuring corporate bonds and EM Debt.
    If however U.S. credit rating is downgraded again the reaction of the bond market will be “less straightforward.”
    UBS has an ultra bear case in which Congress fails to avert the fiscal cliff and fails to extend the debt ceiling. In this case, the United States would be in technical default, and a resulting sell off could cause rates to rise.

Societe Generale

    Treasury issuance could shrink dramatically from $1.2 trillion in the current fiscal year, to about US$700-billion in FY2013, and US$370-billion by FY2015.

Source: UBS / Societe Generale

 

[Brad Sallows]

I don't get all the lip-quivering.  All the temporary measures were just that - temporary.  Most should not have been undertaken in the first place.  Fiscal corrections have to be allowed to work through.  People have to be able to pay down their debts without being further indebted by governments.  If you spend future income "today", you have to accept less spending "tomorrow".

This is just the way the US economy is and will continue to be, given current policy preferences.  There isn't another dot-com bubble around the corner to provide an excuse for dim-witted partisans to pretend the president is a fiscal genius.  Democratic policies require much higher taxes on a much larger segment of the population than just "the rich".  The "fiscal cliff" isn't an extraordinary difficulty to be avoided; it is merely the next step towards higher public spending (thus higher taxation) necessary to support the "American liberal" project.  People - especially the "reality-based community" - need to stop fooling themselves about the implications of future entitlement promises.  Those unwilling to divert themselves from their self-indulgent lifestyles long enough to raise sizable broods of children either have to pay a lot more in right now, or accept an austere retirement.

 

[a_majoor]

Brad, while you are correct on all counts, the reality is ordinary people in the United States and throughout the world will be deeply affected by this, since the American political class seems determined to play "chicken" right to the end.

In some senses this would actually be a good thing; the sequestration would produce real spending cuts rather than the phantom ones that are either projected years into the future or are simply reduced spending increases. The short term fallout will be quite intense (as the opening post indicates) and Canada is in a particularly poor position, since we are essentially like a lifeboat tied to the Titanic. No matter how well the GoC manages the economy, if the US tanks there is little we can do to mitigate the negative effects. Consider how the American U3 of 11.2% affects us; an adult population of Americans equal to the entire population of Canada is in no position to spend money purchasing our goods and services, negatively affecting our export industries.

Still, taking the hit will allow long term recovery to finally take place; the fiscal crisis is at the bottom a debt crisis, and the effects we are seeing are mostly due to the various governments around the world frantically attempting to prevent deleveraging. In some respects this is a replay of the situation at the heart of the Great Depression; so many of the world's leading powers had gone deeply into debt in order to prosecute the Great War that there was an immense "overhang" of debt that needed to be cleared somehow. The solutions chosen in the 1930's had certain negative effects....

 

[tomahawk6]

President Obama in his first 3 years or so in office spent $6 trillion. Rolling spending back to say $1 trillion would be a step in the right direction. Current Federal revenues are $2.3 Trillion.

 

[Pieman]

Cliff or no cliff, I've gotten off this sinking ship.

Zero out debt, Pull investments (not that I had a lot to begin with), secure land ownership, transfer nest egg of money into precious metals (small bars of silver and gold).

If she tanks, zero worries.

 

[kevincanada]

They'll probably extend the deadline if nothing is sorted out.  Even if it is or is not worked out or extended.  Come the new year they'll be back at it over the debt ceiling and a new set of $$$$ problems with that!

 

[cupper]

Extending the deadline won't resolve the biggest problem with the US Economy right now - Uncertainty.

Because Congress opted to keep kicking the can down the road, long term planning can't be done.

I think what is going to occur come January 2nd is that an agreement not having been reached, the debate will switch to cutting taxes on the middle class, restoring or nullifying the more economically damaging parts of the "fiscal long low slope" to avoid a recession.

One point to remember is that the majority of the measures such as income tax hikes won't be felt until year end 2013, providing a significant amount of time for Congress to piss away before finding a last minute solution on New Years Eve 2013. </ ironic but true sarcasm off >

Add to that rolling back immediately implemented measures could be made retroactive to Jan. 2nd.

But again this just puts us back to where we were on December 31st 2012. And without any additional certainty.

 

[kevincanada]

Same problem we had here before the Conservative Majority government,  opposition did anything to boot out the conservatives.  Same thing is happening in the states I believe.  Republicans control the House of Representatives.  If it was democratic party controlled, this fiscal cliff would of been already resolved.

 

[a_majoor]

Same problem we had here before the Conservative Majority government,  opposition did anything to boot out the conservatives.  Same thing is happening in the states I believe.  Republicans control the House of Representatives.  If it was democratic party controlled, this fiscal cliff would of been already resolved.

Look at the spending record from the Democrats assuming a majority in the House and Senate in 2006 to the Republicans taking the House in the 2010 mid terms and try that again.

 

[kevincanada]

I'm not talking about numbers, I'm saying that proposal after proposal is shot down by the Republicans.  I'm not saying The democrats idea's are good or bad,  The tug of war has already caused a credit downgrade.  Even if Obama plan was horrible, if the house was democratic controlled the fiscal cliff would of already been dealt with.  It would of been voted through.

 

[Brad Sallows]

Not all proposals are of equal value.  I could enter a wage negotiation demanding an outlandish increase, but I should not expect it to be taken seriously or serve as one endpoint for splitting the difference.

 

[tomahawk6]

Obama spent $6 trillion with no spending cuts. Now he wants to spend more money and spending cuts 10 years out. Obama isnt serious about cuts in entitlement programs. But he wants to raise taxes on millionaires. Look to France to see how that is working out.

 

[ModlrMike]

A BBC article to illustrate the point:

http://www.bbc.co.uk/news/world-europe-20760572

There are some 2,800 French living in the same area of Belgium a few minutes' drive from the border, including the Mulliez family, owners of the French hypermarket chain Auchan and the Decathlon sports stores, who have lived there for years. Belgian residents do not pay capital gains tax on the sale of shares or wealth tax.

 

[a_majoor]

I'm not talking about numbers, I'm saying that proposal after proposal is shot down by the Republicans Democrat Senate and President.

Fixed that for you

 

[kevincanada]

Obama spent $6 trillion with no spending cuts. Now he wants to spend more money and spending cuts 10 years out. Obama isnt serious about cuts in entitlement programs. But he wants to raise taxes on millionaires. Look to France to see how that is working out.

Millionaires have been making request for higher taxes on themselves in the form of fixing loop holes and some willing to pay more.  It started with Warren Buffet.  More followed suite.  The issue wasn't so much higher taxes, as it is plugging the loop holes,  Buffet released his income tax statement, he paid something like 7% income tax,  He paid a lower margin than the working class.

 

[kevincanada]

Fixed that for you

Let me fix yours, the public have spoken they want Obama, doesn't matter how much you or I may or may not agree with republicans.  It's a democracy, Majority voted for a Democrat.  You're stuck, live with it ;D

 

[Sythen]

Let me fix yours, the public have spoken they want Obama, doesn't matter how much you or I may or may not agree with republicans.  It's a democracy, Majority voted for a Democrat.  You're stuck, live with it ;D

And this means that those Republicans who hold office should just do everything Obama wants? Doesn't matter that they were democratically elected and are expected to serve their constituents, right? Whatever King Obama decrees must come to pass, no matter how ridiculous or nonsensical it is! Where was this attitude when President Bush was in office?

Also in regards to millionaires asking for higher taxes.. Wonder what the percentages of them is? I'd imagine its very low, though I am not gonna do the actual research in to it.

 

[Haletown]

The tax the rich discussion is a pleasant diversion from reality that Obama will have all day because it diverts attention from the real problem.

The tax the rich scam might raise $80 billion a year in additional revenues. 

Obama has, in the first two months of the current fiscal year, run up deficit spending of $300 billion, en route to a new and staggering deficit closing in on $2 Trillion dollars.

Ignored by a sycophantic press corps that lick his boots, Obama can run the field with a spend, spend, spend, borrow, borrow, borrow program that is out of control, out of ideas and running out of fiscal room.

 

[Edward Campbell]

In an article with which I, mostly, disagree, Diane Francis of the Financial Post describes a "grand bargin" which many Americans want: "higher taxes, cuts in government services and military downsizing while preserving Medicare and Social Security." My guess is that Francis is partly right and that the POTUS and Congress will:

1. Agree to something like this to avoid the fiscal cliff; and

2. Kick the can down the road to delay the inevitable which includes new, steeper tax increases ~ maybe through tax code reform, and deep spending cuts, including reforms to social programmes and to defence procurement.

But, sooner rather than later, the fiscal realities will have to be faced by a president and a Congress who are, all, now, too cowardly to face the wrath of an entitled America. This happened to us, although we had the luxury of doing it in relatively slow motion from about 1990 (when Mulroney balanced the operating budget but failed to attack the 'structural' deficit because he, too, was afraid of the reaction of e.g. seniors) until now ~ we are stil doing it by e.g. reforming OAS; it is happening, right now, to the Brits; Americans will, eventually, have to grow up and spit out the government pacifier on which they, as a nation, have been sucking since circa 1935.

The basic point is that all modern, sophisticated, civilized nations have and sustain social and medical programmes that aim to prevent catastrophic age or health related financial problems for almost everyone. America wants and needs to do the same ~ but America can only have those civilized programmes by balancing its budgets (federal, state and local). Other countries - like Canada and Norway - can manage, so can the USA ... if Americans will let it.

 

[ModlrMike]

Maybe they could find some money by trimming Obamacare back to catastrophic coverage only. You need a couple of stitches = you pay, you need a tetanus shot = you pay, you need your arm sewn back on = insurance pays.

I don't think the US can manage truly universal coverage, hell we can't and we've been trying for 50 years.