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Fiscal cliff collapses the economy

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Fiscal cliff collapses the economy

Maximillian Walsh (writer for the Australian Financial Review) October 25, 2012 “Good ship QE3 must reverse sometime” Lexis

Even though fiscal gridlock has meant Ben Bernanke has, in effect, been operating with one arm tied behind his back, his monetary strategy has been courageous and reasonably effective. The US still has a way to go but its recovery to date has been in line with the experience of previous systemic financial crises as outlined by Carmen Reinhart and Kenneth Rogoff in their timely study, This Time is Different: Eight Centuries of Financial Folly. Full recovery from such episodes averages out at about 10 years. Output in the US rose above its pre-crisis peak in the second half of 2011 - a result that put it ahead of most developed economies. Since then, however, the US, along with rest of the developed world, has lost some momentum. The IMF's World Economic Outlook, published this month, reports there is now a one in six chance of global growth falling below 2 per cent. For the US the biggest immediate risk is the so-called fiscal cliff - drastic and automatic tax increases and spending cutbacks - scheduled to come into effect on January 1. The conventional wisdom is that these measures will be postponed by Congress in the lame-duck session after the coming presidential election. Winston Churchill's observation that the US always does the right thing after all other options have been tried, is widely quoted to support the conventional wisdom. That wasn't the case in 1930, when Congress gave open slather to vested interests and brought down what was the most protectionist bill in US history - the Smoot-Hawley Tariff Act. This became the excuse for other countries to introduce "beggar-thy-neighbour" policies that exacerbated the contraction in global trade and deepened the Great Depression. This was the outcome predicted by economists who petitioned Congress against Smoot-Hawley. Not surprisingly, the approaching threat of the fiscal cliff and the absence of any engagement in the political area on its consequences is already having a significant impact on the capital investment and employment plans of American industry. It needs to be said that, considering the magnitude of the ongoing financial crisis, the two presidential candidates remain insouciance personified. It's not just the candidates. As John Hussman, an American economic analyst, wrote in his weekly commentary: "We've become desensitised to extraordinary large numbers - if hundreds of billions don't solve the problem, then a few trillion will - ignoring the magnitude of those figures relative to our actual capacity to produce economic output." If the fiscal cliff is not dealt with - and this would involve postponing most of the measures - then the US is headed for recession in 2013 and it will drag the rest of the developed world and quite a swag of the emerging economies down with it.

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