The “Fiscal cliff” is the buzz these days. This is a reference to across-the-board tax cuts due to expire at the end of the year, joined with large government spending cuts set to go into effect at the same time. Economists are predicting that such a convergence will greatly disrupt the economy and throw it into a major recession.
The politicians are posturing while the rest of the country sits back and waits to see if they come up with a compromise. The choices to avoid the fiscal cliff are not attractive. On the one hand, raising the debt ceiling, which I think is a likely scenario, is not a long-term solution, seeing as the U.S. debt now exceeds $16 trillion.
But tax increases, coupled with huge government spending cuts at a time when the U.S. economy is extraordinarily fragile, could not only kill any recovery that may already be under way, but also kill growth and cause unemployment to reach double digits.
The latter scenario isn’t pretty. Savers and investors sell their stocks, fearing a recession will result in lower corporate earnings. The sell-off triggers a stock-market crash, so billions of dollars of wealth on paper disappear. This perceived lost wealth, coupled with a higher tax burden, creates a cutback in consumer spending, which creates lower corporate revenue, which helps fulfill the prophecy of lower corporate earnings. Lower corporate earnings result in expense cutting, which leads to layoffs, which lead to higher unemployment.
On the bright side, interest rates are likely to remain low under this scenario because inflation is not likely to ignite.
Raising the debt ceiling has been the Band-Aid to prevent a fiscal cliff in the past. Proponents of more government borrowing to cover the deficit argue that economic growth eventually will generate enough revenue to reduce the national debt.
There’s one thing that I think is for sure: Any abrupt and radical change will be painful. You can’t take a 5,000-ton freight train moving at 100 miles an hour and expect it to make a hairpin turn without it crashing and burning.
Henry Savage is president of PMC Mortgage in Alexandria. Send email to email@example.com.