A seething cauldron of fiscal lust

Like a tortured saint, the US is trying to find the willpower to reduce the problems posed by its fiscal cliff. But the threat is far more complex than just one precipice.

Oh Lord, grant me chastity – but not yet.
– St Augustine of Hippo.

Global investors and US businesses are getting nervous about the United States’ so-called "fiscal cliff”. Governments and central banks everywhere should be doing the same – the US is not the economic superpower it once was but if it plunges into a self-induced recession next year, all will be worse off.

In fact the world is in the same tortured state as St Augustine, who struggled with lust all his life. Europe and the United States are praying for the strength to be fiscally chaste and to reduce their debts – but please, just not yet.

The Budget Control Act of 2011 was signed into law by President Obama on August 22 last year as part of a Congressional deal to raise the debt limit to $16.4 trillion.

That limit will now be reached by the end of this year and the US will formally default around April if the limit is not raised again during the "lame duck” period between the presidential election on November 6 and inauguration on January 20.

In addition to raising the debt limit, the BCA contained a variety of measures designed to reduce the deficit by $2.1 trillion over ten years. These included $917 billion from statutory caps on discretionary spending plus the establishment of a Joint Select Committee on Deficit Reduction to identify further savings of at least $1.2 trillion over ten years. It’s estimated that 1000 government agencies will have to cut spending, starting January 1 2013.

On top of that a series of tax cuts expire at the same time – last year’s temporary payroll tax cuts, the so-called Bush tax cuts and some temporary tax breaks for businesses. Sharp reductions in Medicare’s payment rates for physicians are due to take effect, and extensions of emergency unemployment benefits are due to expire.

All up, the various spending cuts and tax increases are expected to remove about $600 billion from the economy in 2013 and will cut 4 per cent from GDP. The Congressional Budget Office coyly says this will lead to economic conditions "that will probably be considered a recession”, with GDP contracting and unemployment rising by 1 percentage point.

The problem is that the fiscal cliff is complex series of events, not just one simple precipice. The Budget Control Act is a law that would need to be repealed at the same time as the debt ceiling is raised, and at the same a whole network of tax laws would have to be either extended or changed.

Yesterday the Financial Times quoted a number of US lawmakers, aides and analysts who all said a deal was looking unlikely. There won’t be time to negotiate a deal after the election but in any case, the fractious mood of politics in Washington is expected to continue.

And while some sort of fiscal cliff deal is necessary for the US to avoid recession in 2013, deficit reduction remains necessary to avoid an unsustainable debt blowout over the longer term.

It means that over the next few weeks, markets and US businesses will increasingly focus on America’s fiscal dilemma.

Already there are signs that businesses are closing down their capital spending plans because of the uncertainty. Core capital goods orders have been falling at the annual rate of 18 per cent over the past three months, which is usually a forerunner of recession.

Businesses and investors can see that governments everywhere can’t deal with their mountainous debts without ruining their economies.

As St Augustine found when he went to Carthage at 16: "There seethed all around me a cauldron of lawless loves.”

Follow @AlanKohler on Twitter

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