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Tuesday, November 13, 2012 3:42 AM

Misdiagnosing the Fiscal Cliff; Shrill Voices and Economic Nonsense; Tyranny of Balanced Budgets

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The amount of worry over something that needs to happen is staggering.

I actually hope the fiscal cliff triggers. Better now than what is 100% certain to hit in a more severe way later.

Ideally, I would prefer no tax hikes and massive budget cuts. Senator Rand Paul's plan to balance the budget would have me jumping for joy.

The next best thing would be a small tax hike in return for deep cuts in spending. However, Republicans foolishly killed that idea last summer, even rejecting plans that would cut spending over tax hikes in a ratio of 10-1.

Republicans refused that deal based on the foolish belief that Obama could not possibly win the election.

Well, Obama did win. And now, nearly everyone is screaming in shrill voices about a "fiscal cliff" that really could have and should have happened long ago.

Shrill Voices and Economic Nonsense

Heading up the list of shrill voices is none other than Ambrose Evans-Pritchard who writes World cannot afford second Fiscal Cliff after Europe’s failed attempt.

The story is by now well-known. Unless there is a deal in Congress by the end of the year, the Bush-era tax cuts and the payroll cuts will reverse automatically; extended jobless benefits for the long-term unemployed will be cut off; defence spending will be cut; so on. Everybody’s sacred cow is sacrificed. The combined austerity would be around $700bn over 2013, or 4.5pc of GDP.

The youth jobless rate is 58pc in Greece, 54.2pc in Spain, 35.1pc in Italy, and 25.7pc in France.

Labour economist and Nobel laureate Peter Diamond says the life trajectory of these young people will be damaged. There is almost nothing worse you can do to the productive potential of an economy - and therefore to debt ratios - than locking a great chunk of the future workforce out of the system during their formative years.

“They have a debt problem and an unemployment crisis, but they think it is the other way round,” he said.

The tragedy is that Europe is wasting its last chance to train a workforce for the 21st Century before its demographic crunch hits later this decade. EMU leaders - like the donkey generals of the trenches - are fighting the wrong war. They are crippling a generation. Budget deficits are coming down - though far less than assumed - but the skills deficit of the jobless army is going through the roof. It is the tyranny of the Maastricht Treaty.

It would be a double tragedy if the US succumbed debt fetishism and made the same historic misjudgement.
Tyranny of the Balanced Budget

Regular readers know that I have an on-again, off-again view of Ambrose Evans-Pritchard. When it comes to Keynesian clown economics, it is decidedly off.

If fiscal and monetary stimulus worked, Japan would not be facing its own fiscal cliff, with a debt-to-GDP ratio of 235 percent. If printing money worked, Zimbabwe would be the richest nation on earth.

The idea that balanced budgets will destroy the world is sheer idiocy. Indeed, any household in the US in severe economic straits would tell you (provided they were honest), that prolonged spending more money than they take in is the road to ruin.

But no! Pritchard not only rails against balanced budgets, he also rails against the "tyranny of the Maastricht Treaty" (the treaty that founded the eurozone), which allows for 3 percent deficit spending forever.

What 7th graders can easily understand (and what history has proven) is debt is the problem.

Pritchard, Bernanke, most of Congress, and most economists believe the way out of a debt crisis is to spend more money.

Quite frankly, such policy is pure idiocy.

Fiscal Cliff Compromise

Liam Halligan, also from the Telegraph writes Compromise can save Obama from fiscal cliff.
In 2008, US government debt was 70pc of GDP. Now it is 102pc. The last time it was this high was in the aftermath of the Second World War. Back then, America was a nation in its zenith, about to embark on a population boom and a run of growth and rampant economic development. America today is an ageing society, weighed down with liabilities stretching years into the future.

For above and beyond the impending fiscal shenanigans, there is no sign whatsoever of any political agreement on how to reform old age benefits so as to prevent the derailment of Uncle Sam’s finances over the coming decades as tens of millions of baby boomers retire.

Some want Obama to use the political leverage he has gained from re-election to raise taxes and lock-in higher benefits. The real leverage the president has, in his second and final term, is that he doesn’t need to worry about re-election. That’s why Obama should offer the Republicans a deal to rein in the country’s ballooning entitlement spending before it spirals completely out of control. Only then will he give America the “hope” he so eloquently offered at the start of his presidency.
Political Chicken

Halligan presents an interesting opinion but I have to ask, where the H is there room for compromise?

Obama wants tax hikes, House speaker John Boehner does not want tax hikes but rather closing of loopholes. Is this fertile ground for compromise?

While pondering that question, please consider US plays chicken on edge of fiscal cliff by Rob Harding.
Chicken is not a complicated game. Only one thing can improve your chances of winning: sending a credible signal that you will not be the person to swerve from the collision.

Election over, the Republicans and Democrats are now revving up for the fiscal cliff, and the game is chicken. If there is no deal then everybody loses.
Let's stop right there because Harding is out of his mind. Someone is always a winner, at least in relative terms, and in politics, relative terms is what matters.

The only problem is figuring out who the relative winner is. Had Republicans realized Obama would win this election, they would have made a far different choice in last summer's budget negotiations.

Harding continues ...
If one side swerves then the other wins; and if both swerve – extending all current policy – then we come back next year and do it all again. In order to show that they will not swerve, politicians on both sides are publicly flirting with the idea of going over the cliff, at least temporarily.

If everybody knows how much damage this would do then the credibility of these threats is easy to assess. The danger comes, however, if people have different views of the cost, making their actions less predictable – and so far economists have not helped by sending out a mixed message.
Precisely. The real game of chicken is exactly the opposite of what Harding first suggested. The real game of chicken is neither party can figure out precisely who will benefit from the fiscal cliff.

If neither party can figure that out, they will both agree to kick the can down the road. This is what happened last summer. However, I doubt it will happen again to the same degree again.

President Obama cannot be elected for another term so he has nothing to lose by holding out.

On the other hand, Republicans may have something to lose (the mid-term elections two years from now).

If either side blinks, expect Republicans to blink first.

Don't Fear Fiscal Cliff

In regards to the game of chicken, Democrat senator Patty Murray, co-chair of last year’s deficit supercommittee says Don't Fear Fiscal Cliff

“If the Republicans will not agree with that, we will reach a point at the end of this year where all the tax cuts expire and we’ll start over next year,” said Patty Murray, who was co-chair of last year’s deficit supercommittee, on ABC’s This Week. “And whatever we do will be a tax cut for whatever package we put together. That may be the way to get past this.”

The Washington senator is one of the most senior figures from either party to suggest that temporarily going off the fiscal cliff could be an acceptable way to break the impasse over fiscal policy. Her hard line could strengthen the negotiating position of Democrats but frighten markets.

Going off the cliff would have the political advantage of letting Congress vote for tax cuts, after they go up automatically at the end of the year, rather than voting for tax rises now.
There's an interesting thought: Let the fiscal cliff happen, then pretend to cut taxes days later.

The problem once again (from a political perspective) is figuring out precisely who will benefit from alleged "reduced taxes" even though anyone with an eighth-ounce of common sense will realize taxes were not lowered.

Anatomy of the US Fiscal Cliff

Gavyn Davies writing for the Financial Times has interesting analysis and charts in his post Anatomy of the US Fiscal Cliff.

For starters, not the absolute absurdity of Republican protests over defense cuts.

The key item is in regards to the Bush tax cuts. The problem for those affected (me included) is the Republican leadership that negotiated these terms were arrogant fools thinking Obama had no chance of reelection.

Once again, please do not blame me. I did not vote for Obama. I was all in favor of Rand Paul's budget-balancing proposal that got hardly any votes.

Secondarily, I was in favor of a plan negotiated by Republican senator Tom Colburn as part of the "gang of six" bipartisan senators.

Sadly, those choices may now be off the table for four more years. In the meantime, please ponder this chart.

From that perspective, the fiscal cliff does not seem so bad. Consequences be damned because I will certainly be affected.

Once again, I am not in favor of tax hikes. However, (and unlike most hypocrites in Congress) I am not in favor of deficit spending either.

Options that Republicans had six months ago simply may not be there today. Don't blame the messenger for this sorry state of affairs.

Mike "Mish" Shedlock

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