Everywhere in the financial news the discussion seems to be surrounding the fiscal cliff, and if these articles are to believed, most of them have very dire warnings of what would happen if congress failed to keep us from going over. I just thought I would spend a little time talking about why it may be best to hope for inaction.
First off, if you are unfamiliar with, or confused by this fiscal cliff, head on over to Wikipedia and get a good idea of what the fiscal cliff is.
Alright, now let us discuss. There are a lot of moving parts what with a couple of tax cuts disappearing, Medicare doc fix, unemployment benefit expiration, some new taxes, and spending cuts across many, many government programs. What I want to focus on is that the combination in reduced spending and increased taxes would result in an estimated $560 billion in deficit reduction according to the CBO (Congressional Budget Office). That may be a good thing…in the long run.
In the past the deficit spending pattern would go something like this:
Increased deficit spending occurred during times of war (1915 to 1920 and early to mid 1940s), and economically challenging times (depression in the 1930s). Then in the 1970s and 1980s we started having deficit spending a little more consistently even in times that were not particularly unstable. Since then, only one short period in the late 1990s has not been one of sustained deficit spending.
The old pattern allowed the government flexibility. In normal times the government’s debt load shrank or grew at an insubstantial pace. This meant that if something crazy, like a war, came along that there was plenty of room in which to temporarily ramp up spending. Now the national debt grows in good and bad times alike, leading to this:
Before crisis times around 1860, and right before WWI the total debt as a percent of GDP was almost zero before needing to borrow substantial amounts of money. The follow on after WWI of a depression followed by another world war made the debt load grow to unprecedented heights, but by 1970 even that peak had been whittled back down under 50% of GDP. The problem is that it then started going up again, and never had a significant reduction for over 30 years, so that when the financial crisis started in 2007 we were all ready holding a large amount of debt. The projection up there, CBO alternative fiscal scenario is truly frightening and reminiscent of what has happened to Japan who has been economically stalled out for more than a decade.
That is why it may be best if our government officials fail to act as far as the fiscal cliff goes. Will it cause pain? Yes, the stock market will fall significantly, unemployment will likely remain high for some time, and anything resembling a rebound in housing markets may not happen for any longer. Still, what is the alternative? We continue to spend and take on debt, delaying the day when the pain is felt, and possibly making the eventual fall worse. Deficit reduction is needed, and the total debt load for our country needs to get back into an equilibrium with the production level. Diving off of the fiscal cliff may be the first step toward that balance.