US Fiscal Cliff

Alchemist

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#5
It'd be good if someone would preface it, what the cliff actually is, in simple terms.
This is a very simple explanation:

Under current law, the federal budget deficit in fiscal year 2013 will show a drastic decline from fiscal year 2012 as a result of scheduled increases in taxes and reductions in government spending. The Congressional Budget Office (CBO) estimates that the federal budget deficit of $1.17 trillion in fiscal 2012 will shrink to $612 billion in fiscal 2013. This sharp reduction of the federal budget deficit is referred to as the "fiscal cliff" in the financial media and macroeconomic discussions
http://www.marketoracle.co.uk/Article34838.html

It's called a "cliff" because the deficit will fall sharply, like a cliff.

The GDP of a country depends on the amount of money that is in the economy and how fast the money moves.

For the last few years, US GDP has been been prevented from falling sharply by excessive money printing and excessive spending by the US government.

This high government spending has been financed by debt and as a result US government's debt has risen rapidly in the last few years.

This is unsustainable on the long-term.

Once the taxes are increased and government spending decreased, the deficit will be reduced sharply and the US government will have to borrow much less.

Note: In spite of the fiscal cliff, US government's debt is expected to keep rising in years to come, but at a much slower pace.
 

Alchemist

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Staff member
#6
The exact impact of the fiscal cliff is difficult to guess as we don't know the what the final "deal" will look like.

A sharp cut in deficit will send US into a recession again, but I don't think it will cause major damage to the Indian economy.

In my opinion the Eurozone is still the biggest risk that the global economy faces today.
 
#7
The politicians will play around for a while but will most likely resolve the fiscal cliff in the first couple of weeks of 2013. I don't expect a sharp sell off due to the fiscal cliff or even the debt ceiling which would again come into focus by February 2013.

Markets fall when something unexpected happens, like say the real estate crisis in 2007 or the dot-com crisis in 2000. Those things took everyone by surprise; no one was expecting that and there was a general euphoria.

Everyone knows of the US fiscal cliff, everyone is aware of the debt ceiling, and everyone is trying to resolve the European crisis so these things will not cause a sell off per se.

That said, I expect the beginning of an intermediate term downtrend soon. I don't expect the Nifty to take 6300 which is just around 400 points away. I expect another cycle of yearly consolidation like the fall of 2011 and rise of 2012 (basically back to square one since 2010).
 

Alchemist

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Staff member
#8
A crisis has been averted for now, but still a lot remains to be done.

If Congress passes the fiscal cliff deal at hand, lawmakers will face three more budget deadlines over the next three months. Get ready for the debt ceiling, the sequester part II and the continuing resolution.
3 more fiscal cliffs loom - Dec. 31, 2012

Today, I looked at the history of US debt ceilings.

On September 2007, US government's debt ceiling had been raised from $8.965 trillion to $9.815 trillion.

That was the time when the US subprime crisis had just began to spread.

US's current debt ceiling of $16.394 trillion has already been hit and will have to be increased soon.

In little over 5 years, US government has increased its debt (ceiling) by over $7 trillion dollars.

US government's debt is rising too fast.

Sooner or later, harsh steps will have to be taken.

If not a "cliff", then it will have to be a "slope". There is no third option.
 
#9
What is the long term solution to this? Drastic measures will cause their own set of problems especially given the state of the global economy and always likely to be put off. US is not in a situation like some of the European nations where nobody was ready to lend them money and not likely to be in the foreseeable future. What does it have to change in the long run to fix this?
 

Alchemist

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Staff member
#12
What is the long term solution to this?
I am not an expert on economics, but I feel slightly higher inflation and controlled debasement of the dollar may be the solution for US economy.

As suggested by Krugman and others, the US Federal Reserve should aim for a higher inflation target.

US printed a lot of money and this stabilized the housing market.

There is enough money in the US financial system, but the money is not moving.

Once prices of homes and other things start moving up and money starts losing value, people will start investing (as in economics) and consuming more.

Many economists believe that Japan failed to get out of 1990s economic slump, because its central bank was too sensitive to inflation.

Every time prices started moving up, their central bank raised rates and brought down prices. People took it for granted that prices won't go up in the future and kept delaying investment and consumption.

Also, my personal opinion, along with higher inflation, US should reduce its dependance on foreign debt.

If other nations aren't allowed to invest in US debt, they will be forced to use up their dollars.

This will weaken the US dollar and help US balance its trade.

This wouldn't because the problem is caused by Govt living beyond their means, not people living beyond their means.
US government's debt was manageable a decade ago. Speculative activity in the housing and financial markets brought down the US economy. The government had to borrow and spend heavily to stabilize the economy.

If it weren't for US government's generous spending, the entire global economy would have collapsed in 2008.
 
#13
I am not an expert on economics, but I feel slightly higher inflation and controlled debasement of the dollar may be the solution for US economy.

As suggested by Krugman and others, the US Federal Reserve should aim for a higher inflation target.
Krugman is a very smart person but he is also a very partisan (towards the Democrats). He has been a cheerleader for the Democrats for quite some time.

In the end, there are only 2 ways to reduce debt

1) Reduce spending
2) Generate more income

Anything else is a short term fix.

US has 3 big spending problems

1) The various wars - Neither side wants to stop/reduce spending on the wars. The defense manufacturers/service providers lobby is huge & they pump a lot of money into politicians of both sides. And it's unlikely that this expenditure would be reduced significantly.

2) Big Government - In theory, republicans are for small govt, but in reality most Presidents in the last 30 years has left the Govt bigger than when they took up the Presidency.

Govt should be in very limited amount of things - protecting citizen's rights and properties and basic infrastructure. Everything else should be left totally to private enterprises.

3) Welfare - Current day Democrats will never cut this (Clinton did it though). People on welfare are a big chunk of their voter base.

Previously this was only people welfare but now it also includes corporate welfare - bailing out GM, bailing out AIG etc.

Plus now the latest scam is Green Welfare perpetrated by Obama. Google Solyndra for just one example - there are a lot more.

So essentially spending is never going to reduce.

About Generating income, the Democrats make it increasingly difficult every year. The US has new laws every year - Environment laws, Union Laws and lots of other red tape. How can a US company compete with countries where you can pollute endlessly, make workers work in sweatshops etc. In spite of this US was the #1 manufacturer in the whole world till a few years back, and still #2 even today after China. However, this may get worse. Obamacare may make it even more difficult for companies from 2014 onwards.

So there are long term solutions but they aren't possible with the current politicians. So you have to do patchwork and bandaid solutions like what Krugman suggests. Clinton was the last guy to try and balance the budget. All the guys after him didn't even try.

The US has had the bad luck (or stupidity) of electing 2 really bad Presidents (first Bush & then Obama). It's really difficult to not go down badly after 16 years of bad Presidency.

My ideal long term solution would have been to elect someone like Ron Paul as the President. But that would never happen.

The government had to borrow and spend heavily to stabilize the economy.

If it weren't for US government's generous spending, the entire global economy would have collapsed in 2008.
So let it collapse. The new economy which emerges after the collapse will be intrinsically stronger.

The US should not have bailed out GM. Should not have bailed out AIG. The US should have prosecuted the finance guys who actually did unethical stuff. But again that wouldn't happen - because these guys are huge bundlers for both parties. Who financed Obama's election. The finance guys did and they made sure they didn't go to jail.
 
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Alchemist

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#14
So let it collapse. The new economy which emerges after the collapse will be intrinsically stronger.
I still think inflating the economy would a better idea.

Inflation would reduce the real value of debt, but keep the nominal value same.

Inflation would make everyone poorer, especially those having a large proportion of cash.

However, an economic collapse would take away jobs, assets, homes from millions of people. In short it would completely destroy their lives. Something like what happened during the great depression.

Reducing the value of money is nothing new in economics. It is a tired and tested way to reduce government debt.

In words of Adam Smith:

From the time of Charlemagne among the French, and from that of William the Conqueror among the English, the proportion between the pound, the shilling, and the penny, seems to have been uniformly the same as at present, though the value of each has been very different; for in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins.
 
#15
In words of Adam Smith:
From the time of Charlemagne among the French, and from that of William the Conqueror among the English, the proportion between the pound, the shilling, and the penny, seems to have been uniformly the same as at present, though the value of each has been very different; for in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins.
Let me complete Adam Smith's quote
By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfil their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.
More from Smith
The raising of the denomination of the coin has been the most usual expedient by which a real public bankruptcy has been disguised under the appearance of a pretended payment. If a sixpence, for example, should either by Act of Parliament or Royal Proclamation be raised to the denomination of a shilling, and twenty sixpences to that of a pound sterling, the person who under the old denomination had borrowed twenty shillings, or near four ounces of silver, would, under the new, pay with twenty sixpences, or with something less than two ounces. A national debt of about a hundred and twenty-eight millions, nearly the capital of the funded and unfunded debt of Great Britain, might in this manner be paid with about sixty-four millions of our present money. It would indeed be a pretended payment only, and the creditors of the public would really be defrauded of ten shillings in the pound of what was due to them. The calamity, too, would extend much further than to the creditors of the public, and those of every private person would suffer a proportionable loss; and this without any advantage, but in most cases with a great additional loss, to the creditors of the public. If the creditors of the public, indeed, were generally much in debt to other people, they might in some measure compensate their loss by paying their creditors in the same coin in which the public had paid them. But in most countries the creditors of the public are, the greater part of them, wealthy people, who stand more in the relation of creditors than in that of debtors towards the rest of their fellow-citizens. A pretended payment of this kind, therefore, instead of alleviating, aggravates in most cases the loss of the creditors of the public, and without any advantage to the public, extends the calamity to a great number of other innocent people. It occasions a general and most pernicious subversion of the fortunes of private people, enriching in most cases the idle and profuse debtor at the expence of the industrious and frugal creditor, and transporting a great part of the national capital from the hands which were likely to increase and improve it to those which are likely to dissipate and destroy it. When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonourable to the debtor and least hurtful to the creditor. The honour of a state is surely very poorly provided for when, in order to cover the disgrace of a real bankruptcy, it has recourse to a juggling trick of this kind, so easily seen through, and at the same time so extremely pernicious.
I'll take Adam Smith's economics over Keynesian economics anyday.
 

Alchemist

Administrator
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#16
I'll take Adam Smith's economics over Keynesian economics anyday.
The quote that I posted mentioned that the practice of devaluation was unfair.

From the time of Charlemagne among the French, and from that of William the Conqueror among the English, the proportion between the pound, the shilling, and the penny, seems to have been uniformly the same as at present, though the value of each has been very different; for in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins.
My argument was not about the fairness of any option, but the consequences of accepting/rejecting any one of the option.

Sometimes doctors have to amputate a leg or arm of a patient to save him, but they don't do the same with the brain.

The banking system is the most essential part of an economy. It cannot be allowed to fail.

A banking sector collapse in the US would have had catastrophic consequences, leading to not just financial crises, but also humanitarian crises all around the globe.

Millions and millions, maybe over a billion would have been totally ruined.

Sorry, but I don't agree with the view that such a collapse would have eventually strengthened the US economy.
 
#17
The fault on the part of the government was not in bailing out these companies, but in letting them go unregulated and reach the stage they did. Anybody who thinks that these companies and banks would have collapsed in isolation does not understand economics. A huge number of perfect good companies would have been cut off from funds they to continue function and would also have collapased and the ripple effects would have caused total chaos everywhere. If so many big banks and financial organizations go down at once, economic activity will just come to a standstill and this can quickly lead to social unrest everywhere. Worse still this would have not been restricted to the US.

These banks were allowed to leverage to levels 30/1 , 40/1. I think nobody can even calculated the leverage levels of AIG. This was not just suicidal, but at that stage they were more like suicide bombers who would have taken down everybody with them.
 
#18
I still think inflating the economy would a better idea.
Yes. Also inflation discourages hoarding. In a no inflationary economy if a few people corner most of the wealth, there is nothing the rest can do to improve the quality of their life however hard they work. Inflation works in the favour of people who create wealth and spend it and keeps the ecomony moving. Controlled inflation at reasoable level I feel is good for the economy.

Sometimes doctors have to amputate a leg or arm of a patient to save him, but they don't do the same with the brain.
Or even the heart. The banking system is like heart of the economy and money is like blood. Killing the banking system or not ensuring that these is adequate money supply in the economy is like removing the heart and asking the rest of the organs in the body to function without blood.
 
#19
The quote that I posted mentioned that the practice of devaluation was unfair.
Yes. I sort of misunderstood. Only after re-reading it, I figured it out.
Sometimes doctors have to amputate a leg or arm of a patient to save him, but they don't do the same with the brain.
The banking system is the most essential part of an economy. It cannot be allowed to fail.
I understand your point of view. It's been endorsed by people much smarter than me. But I still don't believe it's the right thing.

In the US, the great depression had a great benefit - the Glass-Steagall Act was established post the great depression. It strengthened financial regulations which turn strengthened the banks and financial industries. Starting from the 60s on, the financial lobby kept applying pressure to loosen or repeat the Glass-Steagall Act. A lot of it was loosened or repealed by mid to end 90s. This is considered as a major cause of the financial crisis.

Actions should have consequences. Otherwise actions keep getting repeated.
If Banks screwed up, they should collapse. Otherwise what's to prevent them from screwing up again.

Assume there are only 2 large banks in the country. And the collapse any one of the banks could cause a major financial crisis. One of the banks is conservative and the other takes outrageous risks knowing that it will be bailed out by the Govt if anything goes wrong. During good times, the 2nd bank outperforms the 1st one wildly. How can the first bank continue with it's conservative path if there are no risk of failure for the 2nd bank?

Assume there are 2 people - one invests his money wisely, and the 2nd one invests wildly. There is an economic crisis in the country. the 2nd guy loses all his money. The first is not doing great but he is at least doing OK. Now the govt prints more money. This benefits the 2nd guy but screws the first guy because the first guy's money is now worth less.

Bailouts and printing money reward people who screwed up. This is just not fair.
Greece bail out essentially saves Greece (the people who screwed up) by screwing Germany (who did everything right).

A banking sector collapse in the US would have had catastrophic consequences, leading to not just financial crises, but also humanitarian crises all around the globe.

Millions and millions, maybe over a billion would have been totally ruined.
All this is speculation. As in most financial stuff, the number of variables are too many for anybody (even a Nobel prize winner or a supercomputer) to predict what would have happen. It's also not laid in stone that it was the bailout and the printing and spending which actually averted the criteria. You can run millions of simulations on computers but in the end they are just simulations. Nobody knows how far the crisis would have gone without interference. Nobody knows for sure what the did the interference did. Nobody can even predict if the stock market is going to up tomorrow or go down. How can anyone think that they can predict the economy as a whole.

Even forgetting banks, why was General Motors bailed out? Shouldn't Ford or Toyota benefited from the fact that they did better than their competitor?
 
#20
Assume there are only 2 large banks in the country. And the collapse any one of the banks could cause a major financial crisis. One of the banks is conservative and the other takes outrageous risks knowing that it will be bailed out by the Govt if anything goes wrong. During good times, the 2nd bank outperforms the 1st one wildly. How can the first bank continue with it's conservative path if there are no risk of failure for the 2nd bank?
Do you really feel the two banks would be functioning in isolation. The operations of the two banks would reasonably intertwined directly and indirectly through their customers that the better bank may find itself in jeopardy. How should the government act then?

Assume there are 2 people - one invests his money wisely, and the 2nd one invests wildly. There is an economic crisis in the country. the 2nd guy loses all his money. The first is not doing great but he is at least doing OK. Now the govt prints more money. This benefits the 2nd guy but screws the first guy because the first guy's money is now worth less.
In this scenario when one has all the wealth and the other nothing, and money supply dries up, neither of them has any incentive to produce and exchange goods. How will the economy move forward? It is absolutely necessary for the government to ensure adequate money supply in the system.


Bailouts and printing money reward people who screwed up. This is just not fair.
Greece bail out essentially saves Greece (the people who screwed up) by screwing Germany (who did everything right).
Germany also benefited substantially and unduly from the common currency. Without it, due to the trade imbalance, the German currency would have appreciated making the German companies less competitive against the local companies of the peripheral countries and this would have acted as a self regulating mechanism. However this didnt happen and Germany found a huge ready market for its goods for a long time without losing competitiveness. The beauty of it is that there is no free lunch. Everybody pays eventually in one way or the other. Same will play out with US and China. For far too long US reaped the benefits of the rest of the world's hard work on the basis of its strong currency resulting in this huge deficit and rendering many of its industries uncompetitive. Like Alchemist said they are gonna have to debase their currency to a more reasonable level. The opposite will probably play out with China.

All this is speculation. As in most financial stuff, the number of variables are too many for anybody (even a Nobel prize winner or a supercomputer) to predict what would have happen. It's also not laid in stone that it was the bailout and the printing and spending which actually averted the criteria. You can run millions of simulations on computers but in the end they are just simulations. Nobody knows how far the crisis would have gone without interference. Nobody knows for sure what the did the interference did. Nobody can even predict if the stock market is going to up tomorrow or go down. How can anyone think that they can predict the economy as a whole.

Even forgetting banks, why was General Motors bailed out? Shouldn't Ford or Toyota benefited from the fact that they did better than their competitor?
It is not speculation. It most certainly would have happened. No supercomputers are needed to understand that nothing functions in isolation. The fortunes of different countries and companies are intertwined in unimaginable ways.

If Ford would have really benefited from GM's collapse why did Ford accompany GM when GM was asking for a bailout.
 
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