Fiscal Cliff and Lucky Charms

by Kirk Kinder on December 30, 2012

We have finally reached the end of the fiscal cliff drama. Tomorrow is the last day, or so we are told. this fiscal cliff is nothing more than an opportunity for ego driven politicians to get on TV. It is a manufactured crisis that draws the nation’s attention to the politicians, rather than where it usually resides like the Dancing with the Stars finals or the latest Kardashian rumor.

I think the best course of action for the country is to go over the cliff. Why? It all has to do with Lucky Charms. I was the type of kid who would eat the grains in my Lucky Charms and leave the colorful marshmallows to the end. My sister, like most kids, would eat the Lucky Charm marshmallows first and then try to get out of eating the “bad stuff.” Mom always made her finish the grains even if she sat at the kitchen table for an hour. While I enjoyed my colorful, marshmallow ending, my sis gagged down the soggy wheat globs (if you ever let cereal sit in a bowl of milk for an hour you know what I mean by wheat glob). I could delay gratification while my sister could not. As I look at the fiscal cliff, my Lucky Charm behavior emerges: take a little pain now and enjoy the ending. The politicians, and most Americans, want their marshmallows now. Their hope is the wheat bits can be avoided altogether. Unfortunately for them, the economy, starring as Mom in this instance, forces you to eat the wheat at some point.

But the media says the fiscal cliff will cause a recession

It might, but it might not. To understand the ramifications, let’s look at the cliff and the two opposing plans out there today (graphs courtesy Agora Financial). If we ride over the cliff, we will experience a $607 Billion event in 2013 ($504 in tax increases and $103 in spending cuts). Our economy is just over $14 Trillion. The cliff amounts to 4.3% of our GDP. Certainly, we would be eating some wheat now as this could retard economic activity, but a $14 Trillion economy won’t be waylaid by a 4% event.

The current plans offered by the President and Republicans are certainly less taxing on the economy today. President Obama wants $1.8 Trillion in tax increases and spending cuts over the next 10 years while the Republicans call for $2.2 Trillion over the same ten year period. Both plans derive the vast majority of spending cuts from Medicare/Medicaid savings. History has shown that these savings never appear. Projected cuts to doctor payouts, thesignificant savings in both plans, are usually overturned at the last minute. So the spending cuts by both plans probably won’t emerge.

If the President and Republican plans would spare the economy in 2013 more than the fiscal cliff, why would I want to recklessly drive over the cliff. It has to do with Lucky Charms. I prefer the whole grains now while they are crunchy, rather than later when the grains are soggy glumps.

 

Learn From History or Repeat It

In This Time Is Different: Eight Centuries of Financial Folly, economists Ken Rogoff and Carmen Reinhart examined 800 years of debt fueled financial crisis. Every single case of currency collapse, high or hyper-inflation, or government defaults happened when a government breached these two metrics: borrowing 40% or more of annual government spending and government debt to GDP of 100% or more. It doesn’t happen immediately upon reaching these levels, but if governments do not alter behaviors shortly after surpassing these metrics, calamity has always ensued. Today, the US government violates both of these metrics.

While the fiscal cliff may harm the economy today, it would reduce our annual deficit from $1.2 Trillion (40% annual borrowing) to $600 Billion (20%). To put this in perspective, a $600 Billion annual deficit would have been a record before 2009. As if I haven’t depressed you enough, Social Security and Medicare spending will strain our budget no matter what in the coming years as the baby boomers retire in mass. The President and Republican plans maintain trillion dollar deficit levels even if the Medicare savings magically appear. A recession today would certainly hurt. However, a normal downturn today certainly trumps a default or currency crisis down the road. We can eat our whole grains now or wait until they turn into a soggy, disgusting mess.

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