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UPDATED! Will the US Fall Over the Fiscal Cliff?

Posted: December 28th, 2012 | Author: | Filed under: Business News | Tags: , , , , , , , , | Comments Off on UPDATED! Will the US Fall Over the Fiscal Cliff?

UPDATE Will the US Fall Over the Fiscal Cliff via Associated PressUS president Barack Obama will return to Washington – from vacation in his home state of Hawaii – to host congressional leaders, including his bitter Republican rivals, in a last-ditch attempt to halt America’s slide over the fiscal cliff.

A White House spokesman said the president would meet House speaker John Boehner and Senate minority leader Mitch McConnell, and Democratic allies Senate majority leader Harry Reid and House minority leader Nancy Pelosi.

The meeting – scheduled for Friday afternoon local time – comes amid bitter partisan exchanges and mounting pessimism over whether a budget deal can be struck.

Before leaving his Hawaiian Christmas vacation, President Obama telephoned congressional leaders to discuss the situation, which could push the US back into recession.

He returned to Washington overnight, but Senator Reid said a deal to avert the $US600 billion package of higher taxes and spending cuts, due to kick in with the New Year, looked unlikely.

With the deadline to solve the latest potential economic crisis in the US rapidly approaching, you have probably heard of the fiscal cliff – but what is it? ::::

US President Obama Returns From Vacation - Will the US Fall Over the Fiscal Cliff

So What is the Fiscal Cliff?

The term fiscal cliff refers to a combination of dramatic spending cuts and tax increases mandated to come into effect in January. To avoid the cliff, US president Barack Obama has to strike an agreement with Republicans who control the US House of Representatives by the end of the year.

The Budget Control Act of 2011 codified in law a grudging political compromise forcing the government to slash spending by $US1.2 trillion over 10 years from January 1.

Next year’s cuts, called sequestration, would be about $US109 billion.

Also on that date, a package of tax reductions and an extension of unemployment benefits will expire, meaning taxes will rise significantly for most Americans.

Democrats and Republicans have long been deadlocked over whether to address a $US1 trillion-plus annual budget gap with higher taxes or lower spending.

The Budget Control Act was a poison-pill deal designed to force them to find a less austere compromise, but political wrangling and dysfunction meant no deal was done, and the deadline is now looming.

What happens if it is not avoided?

The Congressional Budget Office (CBO) says the higher taxes and lowered spending could slice the $US1.1 trillion deficit racked up in the 2012 fiscal year by almost $US500 billion next year.

While this would vastly improve the government’s financial picture, the CBO estimates the shock treatment would send the country back to recession and push the unemployment rate to 9.1 per cent.

Deep cuts would come to both domestic programs and defence spending.

Government suppliers and contractors would lose business, and temporary furloughs could be in store for tens of thousands of federal employees.

Taxes and automatic pay check deductions would increase for most Americans – reducing the cash they have for spending – and taxes on capital gains and dividends would rise, hitting investors.

How is the crisis likely to unfold?

January 1

  • Expiration of low rates for individual ordinary income taxes and investment income taxes (includes capital gains and dividends). The low rates were enacted under former Republican president George W Bush on a “temporary” basis, and extended in 2010 during Obama’s first term as president.
  • Expiration of Obama’s payroll tax cuts of 2011 and 2012.
  • Return of caps on personal exemptions and itemised deductions for upper-income taxpayers, which were ended by Bush.
  • New taxes take effect under Obama’s healthcare overhaul including 0.9 percentage point increase in wage income tax and 3.8 per cent Medicare tax on investment for high income earners and investors.
  • Estate tax on assets left to heirs will rise to 55 per cent after the first $US1 million (which is exempt from tax). Current level is 35 per cent after $US5 million.

January 2

  • Spending cuts of $US1.2 trillion over 10 years would begin. Known as “sequestration,” these were put in place in 2011 after a congressional “super committee” failed to devise a fiscal plan.

January 3

  • Congress scheduled to convene.

February

  • White House releases annual proposed budget.
  • Treasury exhausts so-called extraordinary measures to postpone the arrival of the US debt ceiling. Without action to raise it, the United States faces possible credit rating downgrade again

March

  • Funding of federal government could expire if no resolution is reached.

What is the debt ceiling?

The US government will hit its statutory $US16.39 trillion debt limit on December 31, according to treasury secretary Timothy Geithner.

The limit is set by Congress and if it is not raised, the US will not be able to borrow any more money and would, in theory, be forced to slash spending to make ends meet.

Possible, but desperate, remedies would include halting pay to the military, retirement health benefits, social security and failing to pay government debts.

Will the US default on its debt?

Not immediately.

The treasury has various extraordinary measures in its armoury, including halting the issuance of securities to state and local governments, which could buy about two months of leeway.

What would a default mean?

No-one is sure: the dollar and US treasury bonds are the primary currency of global finance, and holders do not really have any alternatives.

Most believe that eventually the US government would make good on its debts.

However, the country’s credit rating could be further downgraded, likely pushing up its borrowing costs over the medium-term and possibly diminishing the dollar’s cachet in world finance.

What will Congress do?

Eventually, Congress is likely to raise the debt ceiling, but Republicans who run the House of Representatives will use the showdown as leverage to demand spending cuts from the president in return.

It is uncertain how high the raised borrowing limit will be, and in any case, any resolution will likely trigger a new confrontation between Mr Obama and Republicans the next time around.

But…

Even as the president returned to Washington overnight,  Senator Reid said a deal to avert the $US600 billion package of higher taxes and spending cuts, due to kick in with the New Year, looked unlikely.

“It looks like that is where we’re headed,” he said.

“I have to be honest … I don’t know time wise how [a resolution] can happen.

The House of Representatives will reconvene at an urgent session on Sunday (local time) in a bid to reach a bipartisan agreement to stave off the crisis.

Speaking in the Senate, Mr Reid criticised Mr Boehner for interfering with negotiations.

“It’s being operated with a dictatorship of the speaker, not allowing a vast majority of the House of Representatives to get what they want,” he said.

And he said Mr Boehner’s failed effort last week to push his own solution through the house was a “debacle”.

Mr Reid also accused Mr Boehner of delaying action until after he seeks re-election as speaker on January 3.

“John Boehner seems to care more about keeping his speakership than about keeping the nation on firm financial footing,” he said.

The pessimistic remarks sent US shares lower. US stocks were down for the fourth straight day, dropping more than 1 per cent at one stage, before bouncing back to finish just 0.1 per cent lower.

US consumer confidence has also been driven lower this month on fears of sharp tax increases and government spending cuts.

But the number of people seeking unemployment benefits in the past month has fallen to its lowest level in almost five years, while new home sales have jumped to their highest level in two-and-a-half years.

Although there’s no apparent sign of any headway being made to break the impasse, Republicans and Democrats could indicate they are willing to postpone the full impact of the $500 billion in tax increases and spending cuts while further discussions take place.

“There is a scenario where it’s a short term move off the cliff, perhaps for a few days, and market reaction is quite negative and politicians realise the urgency and they pass some sort of deal to at least buy time,” senior Bank of America-Merrill Lynch economist Michelle Meyer said.

“The worse case scenario however is if we fall off the cliff and stay off the cliff for a while, that really could have lasting implications for the US economy.”

Dr David Smith, an American politics lecturer at Sydney University, told Radio National the full effect of the changes would take a few weeks to kick in.

“They will have about a month or so to actually decide, should no deal get done, what they actually have to cut [within each government department],” he explained.

“This is why some US experts are saying that, well if they go over the fiscal cliff for maybe a couple of weeks or a month, then it won’t be so bad because you won’t actually have those cuts really taking effect yet.”

As if the fiscal cliff dilemma is not enough, US treasury secretary Tim Geithner says the nation will hit its $16.4 trillion debt ceiling on New Year’s Eve, and that Treasury is now beginning “extraordinary measures” to buy more time and avoid default.

US Fiscal Cliff - House speaker John Boehner met with Republicans before the vote via AFP Molly Riley

US House Votes Yes…

UPDATE! January 2 2013: After bitter New Year brinkmanship the US Congress finally backed a deal to avert a fiscal cliff of tax hikes and massive spending cuts that had threatened to unleash economic calamity.

The House of Representatives late Tuesday passed a deal between the White House and Republicans to raise taxes on the rich and put off automatic $US109 billion budget cuts for two months, lifting the clouds of immediate crisis.

The deal’s fate had hung in the balance for hours as House conservatives sought to add spending reductions to a version passed by the Senate in the early hours of 2013 that would likely have killed the compromise.

In the end, the House voted 257 to 167 to pass the original bill with minority Democrats joining a smaller band of majority Republicans to pass the legislation after a fiercely contested and unusual session on New Year’s Day.

The fiscal cliff deal

  • Postpones first round of automatic spending cuts for two months
  • Raises $US620 billion over 10 years through tax increases on wealthier Americans
  • Permanently extends tax cuts for income below $US400,000 per person or $US450,000 per family
  • Income above that level will be taxed at 39.6 per cent, up from 35 per cent
  • Raises estate tax rate to 40 per cent for estates of more than $US10 million per couple
  • Extends unemployment insurance benefits for one year for 2 million people
  • Extends child tax credit, earned income tax credit, and tuition tax credit for five years
  • Avoids a cut in payments to doctors treating patients on Medicare

President Barack Obama, who campaigned for re-election on a platform of building a more equitable economic system, declared the deal was a promise kept, despite falling short of earlier hopes for a grand deficit bargain.

“I will sign a law that raises taxes on the wealthiest 2 per cent of Americans while preventing a middle-class tax hike that could have sent the economy back into recession,” Mr Obama said after the vote.

“The deficit needs to be reduced in a way that’s balanced. Everyone pays their fair share. Everyone does their part,” he said, before heading to Air Force One to resume his interrupted annual vacation in his native Hawaii.

Had the deal splintered, all Americans would have been hit by tax increases and the spending cuts would have kicked in across the government, in a combined $US500 billion shock that could have rocked the fragile recovery.

The House vote took place after a conservative rebellion fizzled when it became clear there were not sufficient votes in the restive Republican caucus to send an amended version of the bill cuts back to the Senate.

Republican party leaders ultimately feared they would carry the can if the deal collapsed, leaving Americans enraged by higher taxes and the prospect that an economy slowly recovering from crisis could be plunged back into recession.

The political feuding which spanned the Christmas and New Year holidays reflected the near impossibility in forging compromise in Washington, where power is divided between a Democratic president and the Republican House.

It was also a signal that Mr Obama, despite a thumping re-election win in November, may find it tough to achieve second-term legislative goals that include immigration reform, clean energy legislation and gun control.

The truce in dysfunctional Washington is likely to be brief, given the fight that will ensue over the spending cuts that now loom at the end of February as well as over regular budget bill extensions.

Those fights will be paralleled by one over Mr Obama’s request for Congress to lift the country’s $US16 trillion debt ceiling.

Republicans are already demanding concessions on expenditures in return for allowing it to rise.

The president issued a blunt warning after the vote that he would not play ball with Republicans by enjoining in another batter over the debt ceiling.

“If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic, far worse than the impact of a fiscal cliff,” he said.

House speaker John Boehner, smarting from a defeat by the re-elected president on tax rates, warned the focus would now turn to Republican turf of tightening the budget.

“Now the focus turns to spending. The American people re-elected a Republican majority in the House, and we will use it in 2013 to hold the president accountable for the balanced approach he promised,” Mr Boehner said.

The Republican leader promised “significant spending cuts and reforms to the entitlement (social welfare) programs that are driving our country deeper and deeper into debt”.

Senate Republican minority leader Mitch McConnell, a key figure in engineering the fiscal cliff deal, also warned of spending cuts.

“That’s a debate the American people want. It’s the debate we’ll have next. And it’s a debate Republicans are ready for.”

Stock markets, which had been likely to plunge if the deal had foundered, reacted positively to the news with indices in Asia rising sharply.

The deal to avert the fiscal cliff raised income taxes only on households earning more than $US450,000 a year and exempted anyone else.

The deal also included an end to a temporary 2 per cent cut to payroll taxes for social security retirement savings – meaning all Americans will pay a little more – and changes to inheritance and investment taxes.

UPDATE Will the US Fall Over the Fiscal Cliff - President Obama Signs Off on Cliff Hanger

Fiscal Cliff Fizzle!

UPDATE! January 2 2013: The United States government has successfully avoided the catastrophe dubbed the “fiscal cliff” but there is now a new concern.

The government has hit a debt ceiling and will need to raise the amount it is legally allowed to borrow.

The US president, Barack Obama, was upbeat after successfully negotiating a tax increase for America’s rich, sparing the country’s middle-class.

“Thanks to the votes of Democrats and Republicans in Congress, I will sign a law that raises taxes on the wealthiest 2 per cent of Americans while preventing a middle-class tax hike that could have sent the economy back into recession and obviously had a severe impact on families all across America,” he told reporters.

The deal also means that many US companies will still get tax credits for the research they do. In addition, two million Americans will also continue to receive unemployment benefits.

Economists around the globe were noticeably relieved!

“Obviously, the consequences of this if it really had hit and there was no sort of preventing it happening, that would be about a 4.5 per cent drop in GDP to the US and obviously have a major effect on the rest of the world,” said David Blanchflower, a former Bank of England policymaker.

“So I think the world breathes a sigh of relief.”

There may be less anxiety now, but the US president conceded there was still more work to be done to put the US budget in a sustainable position.

“There will be more deficit reduction as Congress decides what to do about the automatic spending cuts that we have now delayed for two months,” Mr Obama added.

The president said that very casually, but it does have the potential to become a serious problem.

While the majority of Americans will not suffer tax increases, the issue of where to cut government spending has not been resolved.

Put simply, the US government is spending beyond its means and has now officially borrowed as much money as it currently legally can – around $16.4 trillion.

US Fiscal Cliff - The Clock is Still Ticking

The debt ceiling has been reached!

“With these tax delays or tax reversals, that will mean that the US debt to GDP on a gross basis anyway will reach a record high in 2015 of 120 per cent of GDP,” said Matt Sherwood, the head of investment strategy at Perpetual.

“That is what people are trying to get Greece down to by 2020. So America is certainly not the shining light that it once was on this front.”

Mr Sherwood says if you thought finding agreement on tax increases was hard for Congress, spending cuts will be a far tougher proposition.

“This is something that they’re very ideologically constipated about,” he added.

“What we are going to see in the next couple of months, of course, is that as these spending cuts come to the fore, markets are probably going to get a little bit more jittery if the noises from the Congress aren’t of a negotiated agreement.”

There are now two major hurdles for the US government to overcome.

They include finding a way to cut tens of billions of dollars from the budget, and getting agreement from Republicans on the amount the country can borrow.

The chief economist at UBS Australia, Scott Haslem, says it is creating a dangerous environment for financial markets.

“The delay in government cuts for two months brings that right up to the where it is likely to going to hit the debt ceiling, and so I expect we are going to be seeing some pretty tense negotiations by the end of February again in the US,” he predicted.

The US treasury secretary Timothy Geithner has arranged a kind of bridging finance to keep the US government afloat until the end of February.

Global markets staged a relief rally!

UPDATED! January 2 2013:  Global markets staged a relief rally after US politicians made a deal to stop the US economy falling off the so-called fiscal cliff, at least for now.

The agreement raises $US620 billion over 10 years through tax increases on wealthier Americans and permanently extends tax cuts for those earning below $US400,000 for an individual or $US450,000 for a household.

However, the deal has only postponed negotiations over spending cuts and the government debt ceiling by two months.

Financial analysts say, in the short term, the deal is good for markets. But in the long-term, more has to be done in the way of spending cuts to sustain investor confidence.

“The huge rally in equities and commodities in response to the fiscal cliff deal was a bit surprising,” said financial analyst John Noonan from Thomson Reuters.

“It is difficult to imagine the post-deal euphoria being sustainable. Uncertainty is bound to grip investors ahead of the debt-ceiling negotiations – that will expose the dysfunctional nature of DC politics all over again in late February.”

Wall Street replicated gains in Europe, Australia and Asia

Wall Street replicated gains in Europe, Australia and Asia

 

  • By the close the Dow Jones Industrial Average added 2.4 per cent, or 308 points, to 13,413.
  • The broader Standard & Poor’s 500 Index advanced 2.1 per cent per cent to 1,457.
  • The technology focused Nasdaq Composite Index jumped 3.1 per cent to 3,112.

UPDATED! January 3 2013: Also helping investor sentiment was an industry report that showed American manufacturing expanded in December after reaching a three-year low a month earlier.

Across the Atlantic, the Stoxx Europe 600 Index jumped 2 per cent to its highest level since February 2011.

  • London’s FTSE 100 index added 2.2 per cent, breaking through the 6,000 mark for first time in 17 months.
  • France’s CAC jumped 2.5 per cent and Germany’s DAX rallied by 2.2 per cent.

Asian markets also soared, with Hong Kong’s Hang Seng jumping 2.9 per cent.

The Australian share market is set to build on yesterday’s solid 1.3 per cent gain. The SPI futures contract is pointing to an increase of a 0.3 per cent at the open.

The gains were not confined to equities. The Australian dollar was the best performing currency on Wednesday, adding 0.9 per cent against the greenback.

Early this morning – January 3 2013 –  the Australian dollar was buying 104.93 US cents, 79.64 euro cents, 64.60 British pence and 91.51 Japanese yen. The spot gold price was higher at $US1685.30 an ounce. West Texas crude oil rose to $US93.14 a barrel.

The world seems to be still turning…

source: reuters

source: associated press

source: afp

source: abc


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