The Upcoming Fiscal Cliff

By David Ruggles, originally published in Auto Finance News

The upcoming “fiscal cliff,” as it’s known in investment circles, is the proverbial “sword of Damocles” hanging over the head of the world economy. Somewhere, Grover Norquist is smiling, while the global economy hangs in the balance. When the country’s two political parties couldn’t agree on a deficit-reduction package ― which the Republicans held as hostage to approving an increase of the country’s debt ceiling a year ago, according to Senate Minority Leader Mitch McConnell ― the two parties entered into a sort of “death pact” known as sequestration. Both parties agreed to concessions previously deemed unpalatable to force them into an agreement before the end of 2012. The concessions have the potential to bring catastrophic impact to the U.S. economy and, hence, to the global economy.

The yearend date was selected because the November presidential election will have been decided, and Congress will be in lame-duck session. In theory, this should make it easier to reach an agreement, but only if the Republicans agree to some tax increases on upper-bracket earners. Under the sequestration agreement, draconian cuts will be imposed on defense and social programs, and the Bush tax cuts will expire, which would bring about tax increases on all taxpayers, not just the top bracket.

The threat of having all the above happen simultaneously has the business community running scared, and with good reason. The spending cuts alone amount to $1.2 trillion evenly split between defense and non-defense spending. The expiring Bush tax cuts will raise taxation at the exact same time federal government spending is cut. One doesn’t have to believe in Keynesian economics to see the potential for short term disaster if agreement isn’t reached on a better balanced plan so the shock of the scheduled tax increases and spending cuts does not occur at the same time.

As of this writing, all of the consternation has yet to spill over to the stock market, as the Dow continues to reach new heights, having restored around $23 trillion in wealth since the Obama stimulus package passed. Whether those two events are connected is anyone’s guess, but the fact remains that many Americans’ IRAs and 401Ks are in much better shape than they were in the fall of 2008. Almost $50 trillion in accumulated wealth evaporated in a short time between the dramatic reduction in household net worth and the tanking of the stock market when the financial crisis hit. Only about half of that has been restored through the stock market, as the housing sector is still shaky. This explains the weak recovery.

At the same time, the credit scores of many consumers have been maimed, preventing them from buying the type of large-ticket items that add manufacturing jobs. Perhaps the electorate will be convinced that a President Mitt Romney can restore the household net worth and quickly heal maimed credit scores while cutting taxes and the deficit. If the electorate is convinced that he can, we will have a new administration come January 2013.

Simultaneously raising taxes and slashing government spending could stop the recovery in its tracks and trigger another recession. As we get closer to year end, if an agreement is not reached early, an unlikely prospect at best, expect the Dow to retreat, car sales to fall off, unemployment to spike, and the ripple impact to affect the global economy while our politicians play brinksmanship with all of our lives.

There is incredible pent-up demand in our economy. The recent small drop in the unemployment rate and the addition of 114,000 jobs should be cause for optimism. To put this in perspective, the 114,000 jobs added in September marked a 900,000 job turnaround from January 2009. Economists say we should achieve around 350,000 additional jobs each month to be considered in robust recovery.

Fitch Ratings and others predict that should agreement not be reached, the result would be another recession.

So how long will it take to heal credit reports and restore household net worth through consumers paying down debt and home prices escalating? Will sequestration take place, taxes rise, and government spending be drastically reduced? Will politicians play with all of our well beings for the sake of partisan ideology? The uncertainty is just another thing holding back recovery.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.