Obama’s win and the Fiscal Cliff tug-of-war!

Obama’s win and the Fiscal Cliff tug-of-war!

What exactly is the Fiscal Cliff?

In late February 2012, Ben Bernanke, chairman of the U.S. Federal Reserve, was the first
person to use the term “fiscal cliff” for this crisis. He described “a massive fiscal cliff of large spending cuts and tax increases” on January 1, 2013.

During a lame duck session in December 2010, Congress passed various acts that extended the Bush tax cuts for an additional two years and “patched” the exemptions to the Alternative Minimum Tax (AMT) for tax year 2011. This act also authorized a one-year reduction in the Social Security (FICA) employee payroll tax. This was extended for an additional year by another act, which also extended federal unemployment benefits and the freeze on Medicare physician payments.

In August 2011, Congress passed the Budget Control Act of 2011 to resolve the debt-ceiling crisis. This law provided for a Joint Select Committee (the “Super committee”) to produce bipartisan legislation by late November that would decrease the deficit by $1.2 trillion over the next ten years. If the committee failed to do so, another part of the Budget Control Act directs automatic across-the-board cuts (known as “sequestrations”), split evenly between defense and domestic spending, beginning January 2, 2013, should the Super committee fail to reach an agreement, which it did. Also, the Affordable Care Act imposed new taxes on families making more than $250,000 a year ($200,000 for individuals) starting at the same time.

The Budget Control Act of 2011 was passed under the political environment of a partisan
stalemate, in which Democrats and Republicans could not agree on how to reduce the deficit. It was thought that the blunt cuts of budget sequestration and sharp revenue increases would be mutually undesirable to both parties and provide an impetus and deadline to bring the sides together to solve the deficit problem.

– Source: Wikipedia

In a nutshell:

Unless the President, a Democrat, and the House of Representatives, with a Republican
majority, can reach agreement on spending cuts, tax increases and lifting the debt ceiling,
huge pre-legislated spending cuts and tax increases will automatically take effect, worth about $600bn. This will have a devastating effect on the world’s largest economy (more than 20% of world GDP) and will, if fully realised, send the US into another recession or maybe worse, a depression.

History:

The bitter fight in between Democrats and Republicans, as the US got closer and closer to the debt ceiling in August 2011, took center stage. The Republicans dug in their heels against tax increases and the Democrats, fighting for the poorer Americans, dug in their heels on spending cuts. No agreement could be reached and the Budget Control Act of 2011 was passed to extend the fight to this November and December.

Effect on the market:

The Dow Jones Index dropped 12% in a short period during July and August 2011 and the JSE All Share Index dropped 13%. Gold was the major beneficiary in this period of uncertainty. The Gold price increased by 26% from $1,520 beginning of July to its all time high of $1,900 early in September. The Gold price in Rand increased 36% from R10,000 to R13,600 as the Rand weakened with other emerging markets.

Where to now?

There is no doubt the Democrats and Republicans have dug in their heels again. Republicans have vowed that they will not agree to any plan that will increase taxes on the rich. In 2011 they could not reach agreement and they now sit with the looming cliff on 1 January 2013. If the cliff is not resolved the implications will be ghastly, a US recession will follow. My take is that they will reach some sort of agreement seconds before the bell tolls. In this period of uncertainty Gold may again be the biggest winner.

– Gerhard Lampen

Head, Sanlam iTrade

No Comments

Post A Comment