Fall off 'fiscal cliff' would not be just a U.S. problem

You will hear a lot of talk in the next few weeks about the "fiscal cliff," over which the U.S. government and economy appear to dangle.

Now the election is finally over, the first order of business is for those old friends Barack Obama and the Republican-controlled Congress to agree on the right blend of tax cuts and spending cuts, to avoid the almost $1 trillion in tax increases and spending cuts mandated by the Budget Control Act of 2011 and several other previously passed laws.

There were significant tax cuts introduced by former president George W. Bush, and those cuts expire at the end of this year. That means higher taxes across the board, so less money for people to spend.

There are also cuts in government spending legislated. These total over $500 billion, about half of which target the military.

Knowing the U.S. government is spending way more than it is taking in, you might be saying, "Great; this is just what they need."

And you're right. Implementation of these measures would result in the biggest one-year drop in the deficit in decades.

Fiscal conservatives might say, "Great. This is just what's needed. They can't keep spending beyond their means. Short-term pain for long-term survival."

And they may be right, but the undesired consequence would likely be plunging the U.S. into recession and the carry-over effect on Canada.

To put numbers on it, let's turn to the Bank of Canada governor Mark Carney, interviewed this week by the CBC.

"They predict four per cent growth in the U.S. in 2013, if the current tax rates and current stimulus programs were to continue. However, the bank expects some tightening (reductions to stimulus programs and tax increases), so they have adjusted this to a 2.5 per cent growth projection. That's a rate we could all live with.

"However, if there is no agreement between the president and Congress, and all projected tax increases and spending cuts are implemented with no compromise, then that will knock off the remaining 2.5 per cent and leave growth at zero. That may be optimistic. A recession is more likely."

The hostage that's expected to be used as a bargaining chip is the U.S. government spending limit. It must be raised in January, or the government will lack the legal authorization to pay its bills. (Remember August 2012? They took this one to the cliff then, resulting in a decrease in the U.S. credit rating.)

Clearly, the stock markets would suffer in the short term, perhaps significantly. Already this week, the markets are lower, with the return of a Republican-dominated Congress and a Democratic president, who have a long track record of not playing well together.

So, can they agree?

The Republicans are demanding continuation of the Bush-era tax cuts for the wealthy. Obama does not agree. Most Republicans want to maintain defence spending. Obama, not so much. There are many such points of disagreement, making it a big challenge, and the likelihood that some half-baked compromise will keep things going for the first months of 2013, with nothing resolved.

Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

David Christianson is a financial planner and adviser. He can be reached at dchristianson@wellwest.ca .

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