Wall Street is rife with speculation about the looming ‘fiscal cliff’ and its impact on financial markets.
“The markets are pulling back, and want to see progress on the fiscal cliff,” said Alan Schwartz, executive chairman of investment firm Guggenheim Partners, at the Bloomberg FX12 Summit in New York on Wednesday.
The mood on Wall Street reflects the somewhat contrarian view that a re-elected President Barack Obama offers a better opportunity for resolving the crisis than would a President-elect Mitt Romney.
“The current attitude is that the election outcome we got is probably the one that gives the best chance of dealing with the cliff,” said Schwartz. “The likelihood of getting all the issues resolved in the next six to eight weeks is unlikely, but we should be able to get some sort of Simpson-Bowles type of backstop.”
The Simpson-Bowles Commission that Schwartz referred to was established by President Obama in 2010 to make recommendations on the fiscal crisis.
“I worry about the ‘Rebel Without a Cause’ syndrome,” said Schwartz, referring to a scene in the 1955 James Dean movie in which two rivals challenge each other to a game where the first to jump out of his car before it goes over a cliff is deemed the “chicken”.
“There’s enough complicated stuff that needs to get decided that the two sides should not engage in a game of chicken,” Schwartz said.
If the fiscal cliff is not resolved, the resulting combination of tax cut expirations and across-the-board spending cuts that will produce a one-half of one per cent drop in real GDP growth in 2013, it would be enough to trigger a recession, according to figures compiled by custodian bank Northern Trust.
“Careening over the fiscal cliff would have a front-loaded impact on 2013 GDP,” said Katherine Nixon, chief investment officer for personal financial services at Northern Trust. “The conventional wisdom is that no-one will allow the U.S. to go into a recession.”
With a ‘grand bargain’ between the White House and Congress unlikely to be struck before the end of the year, the “early indications are for a more compromise-driven dialog between the White House and the House of Representatives”, said Nixon. “Instead of a grand bargain, it will be parsed out and dealt with in pieces.”
However, a case can be made that averting the fiscal cliff will only delay the pain.
If the fiscal cliff is not averted, the resulting reductions in the federal budget deficit will cause the ratio of public debt to GDP to drop from 76.1% in 2013 to a very manageable 58.5% in 2022, according to Northern Trust.
Under an alternative scenario, in which the fiscal cliff is averted, the ratio, according to Northern Trust, will climb to 89.5% in 2022, which would make economic growth unsustainable.
“At or above 90% debt to GDP ratio, almost all productive resources go to servicing the debt, which results in a slow, stagnant economy,” said Nixon. “So while the likelihood is we will see a compromise and won’t go over the fiscal cliff, it’s also likely that this will cause long-term problems.”