Day of Reckoning for Congress & the Economy

A long time reader alerted me to an article that referred to this commentary by Alan Blinder:

Well worth considering.

At some point, the spectacle America is now calling a presidential campaign will turn away from comedy and start focusing on things that really matter—such as the "fiscal cliff" our federal government is rapidly approaching.

The what? A cliff is something from which you don't want to fall. But as I'll explain shortly, a number of decisions to kick the budgetary can down the road have conspired to place a remarkably large fiscal contraction on the calendar for January 2013—unless Congress takes action to avoid it.

Well, that gives Congress plenty of time, right? Yes. But if you're like me, the phrase "unless Congress takes action" sends a chill down your spine—especially since the cliff came about because of Congress's past inability to agree.

Remember the political donnybrook we had last month over extending the Bush tax cuts, the two-point reduction in the payroll tax, and long-term unemployment benefits? That debate was an echo of the even bigger donnybrook our elected representatives had just two months earlier—and which they "solved" at the last moment by kicking the can two months down the road. And that one, you may recall, came about because they were unable to reach agreement on these matters in December 2010. At that time, President Obama and the Republicans kicked one can down the road 12 months (the payroll tax) and another 24 months (the Bush tax cuts).

The result of all this can kicking is that Congress must make all those decisions by January 2013—or defer them yet again. If the House and Senate don't act in time, a list of things will happen that are anathema either to Republicans or Democrats or both. The Bush tax cuts will expire. The temporary payroll tax cut will end. Unemployment benefits will be severely curtailed. And all on Jan. 1, 2013. Happy New Year!

There's more. As part of the deal ending the acrimonious debate over raising the national debt ceiling last August, the president and Congress created the bipartisan Joint Select Committee on Deficit Reduction, commonly known as the "super committee." It was charged with finding ways to trim at least $1.5 trillion from projected deficits over 10 years. Mindful that the committee might not prove to be that super, Congress stipulated that formulaic spending cuts of $1.2 trillion would kick in automatically if the committee failed.

Sure enough, it failed. So those automatic cuts are headed our way starting Jan. 15, 2013. To make this would-be sword of Damocles more frightening, the formula Congress adopted aimed half the cuts straight at the Pentagon.

Now, you don't really believe the defense budget will be cut that much, do you?

Probably the rest won't happen, either. But if it all did, the resulting fiscal contraction—consisting of both tax increases and spending cuts—would be in the neighborhood of 3.5% of gross domestic product, depending on exactly how you count certain items, all at once. That's a big fiscal hit, roughly as big as what a number of European countries are trying to do right now, though with limited success and with notable collateral damage to their economies. An abrupt fiscal contraction of 3.5% of GDP would be a disaster for the United States, highly likely to stifle the recovery.

At this point, you are probably thinking: Well, of course Congress will find ways to wriggle out of its self-imposed budgetary corset. I agree. But the invisible hand won't do it; someone needs to figure out how.
 As I see it, the potential for Obama to be president and the Republicans to control congress is quite high.  Romney, have dragged out the Republican nomination for so long, looks to be a rather weak candidate.  So this leaves us with showmanship and circuses in congress for the balance of 2012 including the presidential race itself.

While calm heads will likely prevail later this year, my view is a serious stock market correction is coming later this spring as Operation Twist unwinds.

Then, as the election draws closer in September or so, the Bernank will be called upon by his political master Mr. Obama to step in with QE4 to save the stock market, and the Obama presidency, in the nick of time.

Oh what a tangled web we weave
When we first practice to deceive!

Sir Walter Scott