Understanding the Fiscal Cliff

With the potential fiscal cliff looming, and the future of financial markets cloudy, many investors have been wary of spending cash. We’ve seen these investor worries represented Wall …

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Fiscal Cliff

With the potential fiscal cliff looming, and the future of financial markets cloudy, many investors have been wary of spending cash. We’ve seen these investor worries represented Wall Street lately, as the stock market has steadily declined. 

If you aren’t sure exactly what the fiscal cliff is, it is relatively easy to understand. It’s the term used to describe what could happen when the Budget Control Act of 2011 goes into effect. Congress and the White House are having trouble deciding ways to avoid approximately $600 billion in tax increases and automatic spending cuts that are schedule to take place in early 2013. Many analysts believe that financial restraint with this money could send the economy into another recession. 

Thousands of government programs are scheduled for severe budget cuts, should terms of the act not be negotiated by the end of 2012. Medicare and the defense budget are both scheduled for automatic cuts should a compromise fail to be reached.
 
There are basically three different ways that U.S. lawmakers can address the fiscal cliff. The problem is that none of them are very appealing. 

Lawmakers could let the Budget Control Act of 2011 go into effect completely un-altered. This would lead to increased taxes and spending cuts. The problem with letting the Budget Control Act of 2011 go into effect is that many of the spending cuts could potentially have a major impact on economic growth and recovery, and possibly send our economy back into recession. On the positive side, though, this would cut the deficit in half.

Another option is to modify the Budget Control Act of 2011, letting some tax increases and spending cuts occur. This would add to the budget, however, leading some analysts to believe that this option could lead the United States down a dangerous road, ending with the U.S.’s economy resembling Europe’s.

The last option would be to find some middle ground, addressing the Budget Control Act of 2011 to a certain extent, while still allowing the economy grow.
 
It’s absolutely imperative that lawmakers come together to find a compromise that could keep us away from the fiscal cliff. The lack of bipartisanship shown by Congress in the past has certainly hurt the stock market recently, as investors have little faith that a compromise will be reached. Investors will continue to shy away from investing as long as the looming threat of the fiscal cliff remains. For investors confused by all this, reading investment books like, Kenneth Fisher’s Only Three Questions, may help figure out the right time to re-enter the market.  

Congress has put off addressing this issue for the last three years. Republicans want avoid any new tax increases, and instead focus on spending cuts. Democrats on the other hand, are looking for a combination of both.
 
The most likely outcome of the fiscal cliff debate is that Congress will avoid addressing the issue right now by pushing through some temporary measures to get us by for now, but with no long term resolution. This scenario is also extremly likely to happen, because the new Congress won’t even be sworn in until after the Budget Control Act of 2011 is scheduled to take effect.

 

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