Before the U.S. election, the single biggest threat to America's still weak economic recovery – and ours – was the looming fiscal cliff. Unfortunately, the cliff edge now seems tougher to avoid in the wake of a status quo election result that only heightens Washington's deep political divisions while doing nothing to change the power dynamics.
With the Republicans – including Tea Party budget slashers – still firmly in control of the House of Representatives and Democrats holding a too slim majority in the Senate to ram through policy changes, the legislative roadblocks to a solution remain firmly in place. And it's hard to see why a re-elected President Barack Obama would suddenly respond favourably to opposition demands he has rejected in the past.
"The bottom line from the U.S. election results is there appears to be no clear mandate, the legislative process will remain difficult, and we continue to stare over the looming fiscal cliff and question how quickly it can be resolved, if at all," RBC Capital noted.
The quick reaction in global markets was a selloff in the U.S. dollar. Initial stock market activity was muted, but the latest stock and bond reaction indicates a growing realization that the fiscal cliff is no mirage. That's in contrast to the equity market's behaviour before the election. It signalled remarkable confidence that the lame-duck Congress would reach a last-minute deal to delay the automatic cuts and hikes to give the new Congress a chance to resolve the budget impasse, much as they did with their earlier deal on raising the debt ceiling. But the scary brinkmanship on display in that battle ought to worry all of us.
One theory is that Republicans and Democrats may be willing to take the country over the cliff for a brief period to quiet their ideological bases and gain some manoeuvring room for a compromise.
The "massive fiscal cliff," in the apt words of Federal Reserve chief Ben Bernanke, who coined the phrase last February, describes hundreds of billions in automatic government spending cuts and tax increases that will take effect Jan. 1 in a budget-deficit reduction orgy, unless the politicians find some middle ground. Economists' estimates of the potential damage vary. But no one doubts it will be severe. One widely circulated projection is that about $800-billion (U.S.) would be carved out of GDP in 2013 – about 4 per cent of the economy.
The Congressional Budget Office concluded last May that real GDP growth would be cut by slightly more than half to 0.5 per cent for all of 2013. But the most damage would occur in a recession-ravaged first half, with the economy shrinking 1.3 per cent and unemployment climbing back toward double digits.
Fearing just such an outcome, BlackRock Investment Institute strategists warned before the election that "the parties are far apart on the basic questions of managing the country's fiscal policies, making it difficult to imagine what compromises might be made to avoid the fiscal cliff."
The election did nothing to clear up this gloomy picture.