The fiscal cliff conspiracy of fear

 
 
The fiscal cliff debate/imbroglio/terror in the United States is full of contradictions and puzzles.
 
For a start, Americans profess to be bored by it and the market is supposed to be ignoring it, yet it's all anyone wants to talk about. I've attended a series of CEO briefings in New York this week, and each one of them has said he or she is being cautious because of the fiscal cliff – cutting employment where possible and holding back investment. Bankers I've spoken to agree that chief executives are, as one, being cautious.
 
There seems to be a wide disconnect between how Wall Street sees it, which is that there will definitely be a deal, and how chief executives see it, which is that there might not be a deal, so better act as if there won't be, just in case.
 
And everyone agrees that if and when there is a deal the market will take off, even though it is supposed to be fully discounting the prospect of a deal already.
 
Having been in the US a few days and listened to a lot of people, I would put the chances of America actually driving over the cliff and causing a recession at about 5 per cent, possibly less.
 
The problem is that it is in the interests of both sides of politics in this country not to give in too easily: they both need to appear to be driving a hard bargain to satisfy their constituents, and therefore must orchestrate an atmosphere of crisis before eventually doing the deal they were going to do all along.
 
It is also in Wall Street's interests to promote the idea of crisis so investors buy and sell shares, and it's always in the media's interest to scare the living shite out of everyone to sell newspapers and generate ratings.
 
So there is a conspiracy between politicians, investment bankers and journalists to keep everyone on edge about the fiscal cliff, which is succeeding to the sorry detriment of the economy, since chief executives aren't spending or employing while it goes on.
 
Why am I so sure the chances of "no deal” are only 5 per cent? Partly because the cliff is not really on December 31, when the Bush tax cuts expire and the legislated spending cuts kick in. It's on or about February 15 when two things happen: first, government departments actually do start running out of money and the IRS has to start withholding income tax at the higher rates, and second, the debt ceiling, now $US16.4 trillion, is reached again.
 
So will the cliff actually happen on February 15, with a reduction to GDP of between 3 and 5 per cent, leading to an instant recession? Well probably not: by far the most likely outcome is a stop-gap extension to existing tax rates and government spending until, say, August or September, along with a promise to agree on a long-term deficit reduction plan by then.
 
In other words, the December 31, 2012 fiscal cliff becomes the August 31, 2013 fiscal cliff, except this time there is no election to distract the players from focusing on a genuine plan. At a guess I'd put this at a 65 per cent probability.
 
The next most likely scenario is that they actually do a deal before February 15, including a long-term deficit reduction plan with a smaller reduction in 2013 than would occur with the fiscal cliff. This is a 30 per cent probability.
 
That leaves 5 per cent probability for no deal and no extension, just calamity. It's not zero, but close, in my view.
 
And they will eventually come up with a long-term plan, because they have to. There is no choice (which is why the chances of that happening by February are 35 per cent – because they might as well do it now). The consensus around Wall Street is that it will be $US2 trillion over ten years, through a mixture of revenue raising and spending cuts.
 
But here's the thing: if America dodges the cliff by deferring it for nine months while the politicians thrash out a plan (most likely) the market will celebrate by going for a run, but chief executives still won't spend or employ in 2013 because they still won't know what GDP will be doing, or what the tax rates on corporate income and dividends will be, or what defence spending will be.
 
So the market will get ahead of itself and end up disappointed, as it so often does.

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