25th Oct 2016


US fiscal cliff not averted, but postponed

  • As US uncertainty will climax in the first quarter, the consequences will be felt in the European election calendar (Photo: EUobserver)

Rather than a deal, the US fiscal cliff talks reflect still another delay. However, the time will run out in the next 4-8 weeks. The net effect will reverberate across Europe and the world economy.

On Tuesday (1 January) House Republicans reversed course, thus clearing the way for House approval for fiscal cliff deal that would avert most tax increase, large cuts in Pentagon spending and other government programs.

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So what’s at stake in the crisis? And what are the likely implications in Europe?

Fiscal cliff as a perfect storm

A ‘perfect storm’ is defined as a critical or disastrous situation created by a powerful concurrence of factors. Similarly, the “fiscal cliff” refers to a convergence of multiple crises, which each could have been contained in the past few years, but which all were deferred until December 31, 2012 – and have now been deferred, again.

The Fed chief Ben Bernanke has hoped to avoid or at least alleviate the impact of such a fiscal cliff by ensuring low interest rates until the mid-2010s – which, in turn, has compelled the European Central Bank (ECB), the Bank of Japan (BoJ) and other major central banks to follow the suit.

The fiscal cliff stems from the bipartisan polarisation over the debt ceiling and the deficit-cutting plan, the Bush tax cuts, unemployment benefits and other outlays, automatic spending cuts (sequester), payroll tax cut, capital gains and dividend taxes. Let’s look at the critical factors.

The deficit/debt burden

Today, the US debt burden exceeds $16.4 trillion, which translates to $143,000 debt per taxpayer and over $52,000 debt per citizen (over $15,000 more than in Greece). What Washington needs urgently is a credible, long-term fiscal adjustment program. The real problem is that Athens has such a program, Washington does not.

In the absence of such an adjustment plan, increased volatility in America has great potential to spread to the Eurozone.

The Bush-era tax cuts

In the absence of substantial changes, the US debt burden will increase by another $10 trillion in the next decade. Almost 40%-50% of the debt can be attributed to the so-called Bush tax cuts for the “rich” (families making more than $250,000 a year).

If Washington allowed them to expire, nearly half of US deficit would dissolve overnight. However, Republicans continue to believe that the Bush tax cuts create jobs, while Democrats would prefer to make such cuts permanent to “middle-class families” (families making less than $250,000 a year).

Automatic spending cuts

In August 2011, when Washington lost its historical triple-A sovereign debt rating, America’s public debt climbed to over $14.2 trillion. In order to avoid comparable problems in the future, the Congress agreed to automatic spending cuts. The assumption was that the two parties would not be so foolish as not to find a bipartisan resolution in time.

Neither Democrats nor Republicans would like to see the sequester take effect in 2013 because it would involve both defence and non-defence outlays. Republicans demand large cuts in discretionary non-defence spending as part of any tax deal (which is unacceptable to Democrats). In turn, Democrats demand substantial cuts in defence spending as part of any deal (which is unacceptable to Republicans).


In November, US unemployment declined to 7.7%, which translates to 12.0 million unemployed Americans. The progress did not result from new jobs, but from people leaving the labour force. In the past three months, US economy has created some 140,000 jobs per month, which is substantially less than the 200,000-300,000 jobs that would characterise a robust recovery. More than 40% of the unemployed have looked for a job more than half a year.

Historically, every major recession since 1958 has witnessed the launch of emergency federal unemployment insurance, which has not been allowed to expire until the unemployment has fallen at least to 7.2% - until the expiration of the current unemployment insurance on December 31, 2012.

So how bad could the fiscal crisis aftermath get in America and how could it affect Europe?

Impact scenarios in Europe

After President George W. Bush’s unilateral security policies, which caused a dramatic rift between the transatlantic partners, the US fiscal crisis is likely to reduce European confidence in Washington’s global leadership.

Recently, Javier Solana, the former EU High Representative for Foreign and Security Policy and Secretary-General of NATO, has argued that, if current economic and strategic trends continue, Asia could soon surpass North America and Europe in global power. In this geopolitical context, he believes that “Europe and the US need each other more than ever, making greater transatlantic cooperation crucial.”

However, the conditions that once fostered transatlantic cooperation are on the decline. Coming after the onset of the global recession in 2008-2009 and the downgrade of the US sovereign credit rating in August 2011, the fiscal crisis has the potential to further erode confidence in free markets and political democracy, while complicating transatlantic cooperation.

Eurozone stagnation

Recently, analysts have been revising their short-term forecasts for the Eurozone slightly upward, primarily on the basis of the ECB’s liquidity injections and low interest rates, and the EU efforts, supported by Germany and France, to ensure bailout in Greece and thus to give Italy and Spain a two-year timeout to get their economies in shape.

Currently, the Eurozone is expected to suffer a mild recession until mid-2013. However, the lingering fiscal cliff is likely to heighten a substantial risk of a loss of market access for some countries and, eventually, coercive debt restructurings and exits in 2014 and beyond, in the Eurozone.

Theoretically, a potentially severe contraction in the fiscal deficit could shave off nearly 4-5% of US GDP in 2013. The more likely scenario is that the hit will reduce growth by some 1%-2%.

Since US growth is likely to remain around 1-2% in 2013, the growth impact could halt US growth in 2013, or, in an adverse scenario, cause a recession in America. That, in turn, would intensify and prolong recessionary conditions in the Eurozone.

Rising unemployment, growing uncertainty

Taking into consideration the deep economic and strategic ties between the United States and Europe, the decline of U.S. GDP by 1-2%, when the Eurozone is suffering a -0.2% to -0.1% recession will at the minimum deepen the Eurozone challenges, prolong the region’s stagnation, complicate the bailout and austerity efforts and increase anxiety and uncertainty.

For all practical purposes, these shifts mean further increases in unemployment and further decreases of economic growth in the Eurozone.

As US uncertainty will climax in the first quarter, the consequences will be felt in the European election calendar – most importantly in the Italian parliamentary elections in spring and German parliamentary elections in fall 2013.

Why the fiscal cliff deal is so difficult?

Before 31 December 2012, the assumption was that, after their failure in November, the Republicans had few alternatives but to agree to President Obama’s ‘grand bargain.’ However, the assumption was flawed.

Of the 234 Republicans elected to the House, barely 6% are in congressional districts where Obama won. Of the 13 states where 14 Republican senators will stand for re-election in 2014, Obama won only one in 2012. That’s about 7%.

Unlike President Obama, congressional Republicans do have to worry about re-election, amidst threats by the party’s conservative right. For the huge majority of Republicans in Congress, a deal would have been far more risky than no deal.

The real issue is how long the ongoing bipartisan talks can linger without an adverse turn and the consequent hit on the U.S. economy.

Dr. Dan Steinbock is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore).


Europe ready to tackle Greek debt relief

The Greek government has built and broadened alliances in EU institutions and member-states that acknowledge the need to restructure the debt and deliver another economic model for the eurozone.

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