Currency trading brokers have long taken notice of a general notion going around in financial circles and being increasingly scrutinized by the media: What if America fell off a fiscal cliff?
Last week, Federal Reserve Chairman Ben Bernanke told the press: “If the fiscal cliff is not addressed I don’t think our tools are strong enough to substantially lower the unemployment rate and to offset the effects of a major fiscal shock”.
And he continued: “I think it’s really important for the fiscal policymakers to work together and try to find a solution for that.”
The fiscal cliff is one of those expressions that have become all too familiar in the past months, as economists and experts are still trying to conceive how to address it and its possible consequences in the American society. But what does a fiscal cliff implies, and is America even close to coming near one?
A fiscal cliff mainly refers to a large reduction in the budget deficit and a corresponding slowing in the economy expected if specific laws are allowed automatically expire or go into effect at the end of 2012.
Specifically, laws that allow tax cuts enacted in 2001 and 2003 scheduled to expire on New Year’s Eve, and $1.2 trillion in budget cuts that will begin to take effect that same day, automatically.
According to economists and currency trading brokers, the tax increases and spending cuts are already holding back economic growth, and a Congress agreement is not expected before the November elections.
But what definite effects would the economy have to endure if indeed no agreement was to be reached and the Fed would take no action to prevent the cliff?
Each of these separately would not be enough to dent the US economy by much. However, put together they are an enormous threat. General perception is that the economy would subtract 2.2 percentage points from 2013 growth and a recession would immediately follow.
For instance, the spending cuts will add up to $100bn pulled out of the economy by the government, in everything from Medicare to Defense expenses. The tax hikes will return taxes to their pre 2003 level, which means the top tax rate for households could be over 39 percent, according to press reports.
“It would cause a recession if not dealt with at all”, says Robert Mellman of J.P. Morgan Chase.
Still, an interesting scenario to consider for currency trading brokers is that the spending cuts might actually bring some kind of relieve to the public deficit. “The spending cuts seem manageable, the biggest cuts going to defense, which are peripheral to much of the real economy. As for the tax cuts, the only debate is whether to keep them for the middle class or to keep them for everybody”, according to an article in The Guardian.