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Nothing to fear in the phoney 'fiscal cliff'

Date

Scott Phillips

Remember the Y2K bug? And the US "debt ceiling" crisis?

Of course you do, but only as historical curiosities, not as events that brought civilisation to its knees.

It didn't seem like that at the time, of course – countless hours of worry and commensurate swings in the stock market were devoted to these two topics.

What about the wars in Iraq and Afghanistan, or the 9/11 attacks on the United States?

Awful situations, all, which bought with them (as a very minor consequence) swooning share prices and fears of economic collapse.

The one no one saw coming

The event which really did hit stock markets for six? The collapse in US house prices, brought on by irresponsible lending, which led to bank failures. Ditto bank and government failures in Europe.

So despite all of the fear and short-term panic brought about by those things we thought we could foresee, it was the one we didn't pick – an unsustainable debt bubble in all of its forms – that did the damage.

Which brings us to the imaginatively-titled "fiscal cliff" in the US.

Lest you think this is some "fall-to-the-death" event, the impact of the worst-case-scenario is economic contraction of about 5 per cent.

Not exactly a "cliff"

If you're wondering, this "cliff" is the confluence of tax increases and government spending reductions that are all scheduled to commence from January 1, 2013, unless the US Congress takes action.

The increase in taxation will remove some discretionary spending from the economy, while the reduction in government spending will do the same. Reduced demand would follow, and the flow-on impact would be significant.

Yes, incredibly unwelcome, and it would set the US recovery back a few years, but it's hardly the stuff of Armageddon.

Of course, the impact is largely irrelevant. This particular situation is eminently understandable and, more importantly, avoidable. The circumstances and the solutions – even if only temporary – are known. They are also under the control of a small number of people, who, even if they argue about how to fix the problem, aren't stupid enough to let the worst-case come to pass.

Bluff and bluster

The logic is pretty simple. Humans – especially politicians – understand the basic instinct of self-preservation. Only in the most dire and unusual of circumstances do we have a "we have to destroy the village to save it" outcome, and popularly elected officials aren't crazy enough to damage the United States' near-term future, and with it, their own political careers.

Yes, the fiscal cliff could be serious, if left untreated. But so can inflation, unemployment, termites and a whole host of potentially serious diseases. But we don't leave those things untreated.

Each is unpleasant if left to its own devices, so we don't leave them to their own devices!

The sky isn't falling

Since President Obama's re-election, the market has taken a pessimistic turn – the Republican-controlled House of Representatives and the Democratic Senate and presidency were seen as signs of potential instability.

Then, overnight, amid reassuring words from US politicians, the S&P 500 jumped 2 per cent. Our market enjoyed a little of that glow this morning, up a more moderate 0.4 per cent at lunchtime.

The Y2K bug was treated before it was allowed to disrupt much at all. The debt ceiling was little more than political brinksmanship writ large, before the inevitable compromise was reached.

Like the old joke that economists have picked nine of the past two recessions, the existence of a possible risk is far from the same thing as that risk being realised.

Foolish takeaway

The end result of the current impasse is easy to predict – it will be solved before it becomes a real problem. How and exactly when is uncertain, but from an investing perspective, it's also largely irrelevant.

If the market wants to panic, at The Motley Fool we'll happily take advantage of lower prices. When investors come back to their senses, either before or after the deal is done, we'll be glad we did.

Sensible investors should be doing exactly the same.

The Motley Fool has just released a brand NEW special free report. BusinessDay readers can click here to receive a copy of The Motley Fool's Top Stock for 2012-13.

Scott Phillips is a Motley Fool investment analyst. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).

31 comments

  • I agree - the republican/democratic obstinance to agree on terms was prior to US general election. Coming to a decision prior to the election would allow either a) a democratic based option which would fall into the hands of allowing President Obama to say that he had resolved the issue and brought the two opposing sides together - easing a victory before polls or b) a Republican option which would be seen that the were in the controlling seat. Now that the election has been finalised, the issue is reduced as the voting public has already made their decision

    Commenter
    Meep
    Date and time
    November 20, 2012, 3:08PM
    • The only people to lose from the fiscal cliff are the super rich who'll have to pay more taxes and the people who pay no income tax who'll get less welfare. The middle class taxpayers will be much the same. The world outside however will breath a lot easier. The pretence of Obama over supposedly trying to negotiate with the Republicans is laughable. He caused the problem in the first place with four years of massive spending increases JUST LIKE WAYNE SWAN HAS DONE HERE FOR FIVE YEARS.

      Commenter
      davey street
      Location
      lane cove
      Date and time
      November 20, 2012, 3:15PM
      • So, you think the Bush administration made no contribution to the US's debts woes when (1) it embarked on two mind-blowingly expensive wars that everyone (except the Bush administration) knew could never be won, and (2) when it insisted on repeatedly reducing taxes for the rich?

        Commenter
        Chris
        Location
        Sydney
        Date and time
        November 20, 2012, 4:34PM
      • The GFC was caused by in turn Reagon who introduced legislation to allow for sub prime morgages, Bush Jnr for reducing regulation and the Illegal gulf war that cost the USA some 8.6 Trillion Dollars and still costing along with the Afghan war.
        Swan saved this nation from going into recession for a cost to be sure but a cost far less than if he did noithing.
        In return we are being positioned to reap the rewards of record infrastructure spending.
        Any business that increases costs and reduces investment is doomed for failure the reason things were going pear shaped under Howard (record taxation rates, hospital & health, Education and roads all failng through lack of investment) Thank Swan for the fact you have a job not make ridiuninformed critic no doubt repeated from Jones and Abbott all of who's comments have been proved delibeate lies and fabrication.

        Commenter
        AustraliaFirst
        Date and time
        November 20, 2012, 4:35PM
      • davey street:
        "He caused the problem in the first place with four years of massive spending increases"

        Actually he inherited the problem from George Bush.

        It was irresponsible tax cuts for the rich over a decade by the Republicans that caused the problem in the same way that John Howard squandered the mining boom on tax cuts for the rich, leaving Labor with a dysfunctional taxation system now the mining boom is starting to falter.

        Commenter
        Goresh
        Location
        Brisbane
        Date and time
        November 20, 2012, 4:40PM
      • Davey street, you'll find that the grotesque increases in federal spending were initiated by G. Bush jnr. Obama didn't reduce them, but he wasn't responsible for the huge deficit. Blame ill-timed tax cuts to the wealthy, and a massive increase in federal government, combined with costly wars for that one. It amazes me that right-wingers fall for this myth time and time again. It's as if they will it away by talk.

        Commenter
        Faniya
        Location
        Melbourne
        Date and time
        November 20, 2012, 4:58PM
    • The article aside (which I have no problems with) - your assertion that the Y2K bug was nothing is naive. Yes - very little went wrong - because millions of hours were spent fixing code before hand. It was never going to be as bad as the commentators said, but it would have had significant impact if it hadn't been rectified. This is a case of people doing too good a job and causing everyone to doubt that it was ever going to be a problem.

      Commenter
      Wayne
      Location
      Brisbane
      Date and time
      November 20, 2012, 3:24PM
      • Wayne, completely agree with you on this point. It galls me that to this day how ignorant people can be about the time, effort and money spent by the industries in fixing this problem. If things had gone wrong, it would be the IT workers' fault. But they don't get any credit for successfully tackling this problem created decades ago.

        Commenter
        Ben-Yamin
        Date and time
        November 20, 2012, 4:30PM
      • some countries (the US and most of the west) spent billions (or earned billions depending on who you were) on Y2K and nothing happend...
        some countries (Russia) spent very little and nothing happend...

        I can't work out who was smarter...?

        Commenter
        samson the cat
        Date and time
        November 20, 2012, 5:10PM
      • Indeed. Havjng been involved in several projects that dealt with cleaning up software that otherwise would have fallen over badly, it makes me wonder what else in this article is non-factual drivel. Samson cat - you believe Russian budget and spending information? Why?

        Commenter
        Brenda Loots
        Location
        Sydney
        Date and time
        November 20, 2012, 6:15PM

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