We should expect at least a Fiscal Clifflet for the US
Two months ago, we got four scenarios for the fiscal cliff via Credit Suisse and Sober Look. All of these scenarios called for at least a 0.9% drag on the economy, meaning that we should fully expect at least a 0.9% drop in annualized GDP because of the fiscal cliff. I think this is the right frame for the fiscal cliff debate as Stan Collender’s column today shows. Collender writes:
How ridiculous is the fiscal cliff debate? The answer is that it’s off-the-wall crazy. Consider the following.
The tax increases and spending cuts that will go into effect as part of the fiscal cliff are the absolutely wrong fiscal policy for the start of 2013 unless you think that causing a recession is a good idea.
There’s little discernible support on Capitol Hill for allowing the fiscal cliff to happen. But the main alternative to that, indeed, the only option that would be the right fiscal policy and ultimately the easiest solution — a 2013 budget deficit that will be much higher than it otherwise will be — is at least as politically toxic as the fiscal cliff itself. As a result, no one dares talk about it, and the discussions about how to avoid the cliff have been limited.
The message from Collender here is the same as we got via Credit Suisse: there will be cuts of some magnitude. What I am hearing is that the payroll tax cuts are likely to expire. And so, Credit Suisse’s Scenario 2 in which we see a 1.5% drag on growth sounds very plausible. And remember, when you talk about deflationary fiscal versus reflationary monetary globally, fiscal wins.
In my view, that puts the US and the global economy in serious danger of recession. So, the politics of austerity and fiscal deficits are very much on display here. The conventional view is that deficits are bad and so large fiscal deficits will be fought. In Europe, because of the euro, this is necessary. Elsewhere where there is more leeway, the cutting has only just begun, but it will happen – and that is negative for growth and earnings. President Obama could actually have the more ‘austere’ policy view because of Republican aversion to tax hikes. As a hedge fund friend told me, “corporate profitability is the flip side of the deficit, and will get crushed if there’s any serious attempt to rein in government spending.”