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November 19, 2012

Chart of the Week: What Does a Fiscal Cliff Look Like?

by Alpha Now Research Team.

The fiscal cliff looms large ahead; this week’s Chart of the Week tries to capture the numbers around which the political debate revolves.

For several weeks to come, the outlook for financial markets – especially in the United States – is likely to revolve in large part around the question of whether the U.S. will be able to avoid running full-tilt off the so-called fiscal cliff. Unless the president and Congress can reach some kind of agreement to slash the deficit by $1.2 trillion between now and January 1, 2013 (and to figure out what to do with Bush-era tax cuts and payroll tax reductions), a toxic combination of $136 billion of spending cuts and $532 billion in new or reinstated taxes would kick in automatically. Economists are largely in agreement that that would be disastrous for the U.S. economy, likely tipping it into recession again as well as damaging its status in the global economy.

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In this week’s Chart of the Week, we tried to capture the nature of the dilemma that faces political leaders. As happened during the last recession, at the beginning of the century, government revenues declined and debt levels spiked at the outset of this recession. What made this an even greater problem for the country’s economic future was the fact that surge in debt came off a higher debt level than was the case back at the end of President Clinton’s term and in the first years of President Bush’s first term in 2001, when the level of federal government debt outstanding was flat and even briefly declined.

While government revenues – which declined at a greater rate during the 2008/2009 financial crisis and recession than they had in the prior recession – resumed their growth again in early 2010, that growth rate has never recovered. The growth in government spending has contracted quite significantly, however, as the chart shows, helping to stem the growth in outstanding debt.

The fiscal cliff negotiations, however, will try to achieve the difficult feat of not just curbing the growth rate of debt or government expenditure, but a significant absolute reduction in both. This will prove to be a political challenge of the highest order, particularly in light of the increasingly contentious and partisan environment in Washington. Pundits watching the negotiations at this early stage agree it’s unlikely that the rival parties will reach any kind of deal to avoid a lemming-like plunge over the fiscal cliff much before the New Year’s Eve deadline.

We’ll continue to watch events here at AlphaNow, and try to gauge their impact on markets as the negotiations unfold.

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