28 December 2012

 Most readers will have come across the expression “Fiscal Cliff” in recent weeks as the US heads for a showdown between Republican and Democrat law makers. As is often the case these days, words and phrases are readily picked up by the media and repeated ad nauseam without much in the way of explanation.

A useful discussionof the mechanics of the so-called “fiscal cliff” appeared today in the Business Spectator publication and is available here.

There has been some speculation that President Obama is not necessarily looking for a speedy resolution to negotiations with the Republicans on this issue. If there is no substantive agreement prior to 31 December, the two main effects are: (i) an end to certain tax cuts and (ii) the implementation of a variety of spending cuts.

One strategy is for the President to then introduce a bill legislating for the re-introduction of tax cuts for all but the top 2% of income earners. This would be very difficult for the Republicans to oppose. Furthermore a significant proportion of the spending cuts relate to defence expenditure which again would hurt the Republicans more than the Democrats. So there is a strong case that President Obama may fare quite well out of any stalemate that ensues over the coming days and weeks. Certainly he is holding a stronger hand that his opponents and, being in his second (and final) term as President, is not looking to curry any favours with the electorate.

Needless to say the markets will be underwhelmed by the uncertainty that would follow a breakdown in negotiations – in which case volatility will be king once again.