The Three 'P's Of The Fiscal Cliff

Tyler Durden's picture

On the basis of a joint press conference following a one-hour chat, the S&P 500 is up over 2.5%; it seems there is little doubt that the fiscal cliff is front-and-center in people's minds. And yet, positioning is far from biased towards negativity and sentiment remains positive - the 'they will fix it; they have to, right?' meme is everywhere. As Morgan Stanley notes, however, a smooth resolution requires some of the same public officials who created the cliff to cooperate to avoid it. As far as hope of a short-term solution, Obama's Burma trip aside, Speaker Boehner has already indicated that it would be inappropriate to pass comprehensive legislation in the Lame Duck session, given that more than 100 current members of the House will not be returning next year; and as for any actual substantive change: the sequence most talked about is patch (stop-gap legislation) and promise (ten-year budget reduction), followed by a plan. In that regard, politicians’ solution to the 2012 fiscal cliff will be to create another one in 2013. Thus, only a portion of the uncertainty about policy will be resolved by the patch and promise, as much could go wrong with the plan.

 

Via Morgan Stanley's Vince Reinhart:

US politicians have purposely put the economy in harm’s way. On January 1, 2013, the federal budget contracts the equivalent of 5 percentage points of nominal GDP for the entire calendar year. This is not an act of nature but the accumulation of poorly drawn legislation, accounting gimmicks, and failed attempts at budget discipline. Added to that budgetary mix—which is all about flows of spending and taxing—is the need to increase the statutory limit on the stock of public debt. Without a hike in the debt ceiling, the Treasury will run out of cash in mid-February.

 

A smooth resolution requires some of the same public officials who created the cliff to cooperate to avoid it. If there is no such cooperation, then the budget lurches into contraction, at least until constituent pressure, adverse financial market dynamics, or the debt ceiling forces agreement.

 

As for timing, the mid-February debt ceiling is a binding constraint, so the two windows for action are the post-election, pre-year-end Lame Duck session of the Congress and the first 45 days or so of 2013.

 

As for substance, the sequence most talked about is patch and promise, followed by a plan. The patch would be stop-gap legislation extending most features of the current system accompanied by the promise of significant ten-year budget reduction legislated by a certain date later in 2013. In that regard, politicians’ solution to the 2012 fiscal cliff will be to create another one in 2013. Thus, only a portion of the uncertainty about policy will be resolved by the patch and promise, as much could go wrong with the plan.

 

Recognizing that there is significant overlap in the major consolidation programs in play, the negotiators could cut to the plan immediately. However, Speaker Boehner has already indicated that it would be inappropriate to pass comprehensive legislation in the Lame Duck session, given that more than 100 current members of the House will not be returning next year. Cutting straight to the plan probably means going over the fiscal cliff. In that scenario, elevated concern about falling off the cliff in 2013 could quickly turn to relief at the announcement of a comprehensive plan.

 

Here is the complication: An early plan most likely requires going over the cliff. However, the converse does not necessarily hold, in that going over the cliff does not guarantee a comprehensive plan. Confrontation and recrimination at the start of 2013 could give way to a quick patch with the promise of a plan later in the year. That is, sound and fury with no reliable output.