Like lemmings, the Americans seem hell-bent on leaping off an economic cliff. The effect on us could be devastating
13:30 GMT, 27 December 2012
As the year draws to a close, we may have survived the end of the world, as foretold by the ancient Mayan civilisation, but we still face financial apocalypse.
This could be our fate unless America’s political extremes can reach agreement in the coming days to keep the country’s economy on track. There is more at stake than just the budget of the world’s most important economy. This crisis questions whether elected politicians are any longer capable of rescuing ailing economies.
We have already witnessed their failure in Europe as national economies have imploded and the eurozone has plunged into deep debt. The armageddon phrase being used to describe what America faces is the ‘fiscal cliff’ — and, like lemmings, many of the country’s decision-makers seem to be heading over the edge.
Warning: The phrase 'fiscal cliff' is attributed to Ben Bernanke (pictured), chairman of the Federal Reserve, America's central bank, who has warned about 'a massive fiscal cliff of large spending cuts and tax increases'
The fiscal cliff refers to the fact that Congress has a legal deadline of January 1 to agree to a new budget.
Failure to do so would mean automatic public spending cuts of $110 billion across all government departments and tax rises of $536 billion — which would remove $600 billion from the economy and send the U.S. and, in turn, much of the rest of the world back into recession.
The phrase ‘fiscal cliff’ is attributed to Ben Bernanke, chairman of the Federal Reserve, America’s central bank, who has warned about ‘a massive fiscal cliff of large spending cuts and tax increases’.
The capacity for politicians’ cynical brinkmanship as they wrestle for the control of America’s economic machine — the most powerful in the world — is astonishing.
On one side is President Barack Obama, who believes that his second term of office gives him the mandate to reverse the emergency tax cuts for the rich he inherited from his Republican predecessor George W. Bush.
Pitted against him are the Republicans — including some of the most extreme elements of the Tea Party, who are ferociously hostile to high-spending government and taxation — who control the House of Representatives.
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All financial Bills begin here and thus its members have extraordinary powers to hold the President to ransom. If these two immovable forces fail to agree a budget deal, sending the U.S. tumbling over the fiscal cliff into an economic nether world, the country faces a future too horrible for any responsible government to contemplate.
The U.S. economy would dive into a deep recession and the unemployment rate, which has gradually fallen over the past 18 months, would soar.
We, in Britain, can only look upon such U.S. fiscal suicide with trepidation. Already our biggest trading partners in the eurozone are ending the year deeply mired in recession and with Europe’s troubles far from resolved.
Spain’s banking system is in meltdown and youth unemployment has reached an obscene 56 per cent. Italy faces a destabilising election campaign as a result of Silvio Berlusconi’s malign reappearance on the political scene.
And France is experiencing an extraordinary loss of confidence as some of its most high-profile entrepreneurs and citizens leave the country rather than face the socialist government’s 75 per cent top rate of tax.
But even more damaging to Britain’s economic prosperity and the Coalition’s fight to deal with the toxic legacy of Labour’s deficits and debt mountain is the health of the U.S. economy.
We tend to forget that the U.S. accounts for 30 per cent of our international trade — against 40 per cent for the 27 nations of the EU. Moreover, Britain is umbilically linked to the U.S. through our financial systems.
Wall Street and the City of London are the two largest financial centres in the world.
Many of the banks that dominate trading in New York, including such high-profile institutions as JP Morgan Chase and Goldman Sachs, hold sway in the City.
Movement of money across the Atlantic — from foreign currency trading, insurance, fund management and other sophisticated financial services — mean we share economic booms and busts with the U.S.
We learned this to our peril with the sub-prime mortgage crisis — when vast quantities of loans were made by U.S. banks to homeowners who could never pay them back — which reached disaster point in 2007-8. We are still paying a huge price for that financial scandal.
Groundwork: Obama wants to cut spending by $925 billion and then to raise a hefty $1.2 trillion in taxes, with the burden largely falling on people earning salaries of more than $1 million
Experts at the International Monetary Fund, among others, argue that the reason employment levels in Britain have remained robust and we saw a recovery in the third quarter of 2012 (when the economy expanded by 0.9 per cent) is because, with our free-market model, we are still closer to North America than to Europe.
But conversely, if the U.S. were to plunge off the fiscal cliff, Britain and much of the rest of the would end up being dragged down, too. That’s why it’s so important that the Democratic White House and Republican House of Representatives stop posturing and reach an agreement.
Ultimately, if politicians fail, investors on Wall Street may yet come to the rescue. For the American people, much more than the British, feel they have a personal stake in capitalism — by ownership of shares, mutual funds (unit trusts), other financial devices and self-invested pensions schemes. And if the politicians continue to shilly-shally, these citizen capitalists will vote with their wallets.
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There is a precedent. In the autumn of 2008, when the investment bank Lehman Brothers collapsed, it was the reaction of the financial markets (where prices fell heavily) that eventually forced the hand of a reluctant Congress to bail out the U.S. banks.
Similarly, in the summer of 2011, when the U.S. faced a similar budget crisis to that posed by the fiscal cliff, it took several days of dramatic falls in share prices to persuade a reluctant Congress to allow the government to borrow more money and avert the crisis.
Until just before Christmas, most U.S. financial commentators were optimistic that the power of the financial markets would, yet again, force the politicians’ hands.
However, at the core of this rancorous dispute are fundamental philosophical differences: the Democrats’s belief that soaking the rich with extra taxes will help the U.S. rebalance its budget; and the Republicans’ moral crusade to shrink the size of the state (though compared with Britain and most of Europe, the federal government is small.)
The Republican leadership, led by House Speaker John Boehner, proposed that half the budget savings of $1 trillion should come from cuts (over the next ten years) and the other $1 trillion from tax increases.
But Obama wants to cut spending by $925 billion and then to raise a hefty $1.2 trillion in taxes, with the burden largely falling on people earning salaries of more than $1 million.
Failure to bridge the gap between the warring sides would be devastating for the U.S. and the world.
For the truth is that the last best hope for a global economic recovery in 2013 and beyond comes from a strong America.
The groundwork for this is already in place. A new era of cheap energy (largely from gas and oil fracking) has already triggered a manufacturing renaissance. U.S. technology is dominating the digital world and the tax cuts introduced under George W. Bush — so much despised by Democrats — have been good for businesses and entrepreneurs.
All of these positive steps risk being sacrificed, leading to devastation in every sector of the U.S. economy and the squeezing of the household incomes of the less well-off.
The great worry is that divisions in Washington are so deep that compromise is impossible. If that proves to be so, then Britain and the rest of the world will also crash down the same fiscal cliff and have to endure years of the crushing slump that will inevitably follow.