The Investment Scientist

Fiscal cliff and investment risk

Posted on: November 21, 2012

Approaching the fiscal cliff

Since the re-election of President Obama, the S&P 500 index has dropped more than 5%; pundits have attributed that to the imminent “fiscal cliff.”

What is the “fiscal cliff”? It is the simultaneous expiration of tax cuts and mandated across-the-board spending cuts that will take effect on January 1st if no agreement is reached between the President and Congress. The combined amount is $669 billion, or about 4% of GDP.

All the talk has been about what happens if this much money is taken out of the economy, which is undergoing a fragile recovery. Will the economy plunge back into recession?  If we fall off the fiscal cliff, will the survival of our nation be at stake?

I highly doubt it. If you have to spend 4% less next year, would you call it “jumping off a cliff?”

Looking at it from another angle, our estimated budget deficit this year is $1.08 trillion. If we fall off the “fiscal cliff,” the combined tax hike and spending cuts would  shrink the deficit by 60%. That’s almost like budgetary nirvana. This can only be good for the nation in the long run.

So the way I see it, even if the President and Congress cannot come to a “grand bargain,” the worst case scenario is short-term pain and long-term gain. If they can mitigate some of the short-term pain, so much the better.

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1 Response to "Fiscal cliff and investment risk"

The first step in turning a failing business is, “Stop doing what you’re doing wrong!” While the govt isn’t a business if we wish to change directions a lot of the same steps as business must be taken.

I suspect we will have 4 more years of changing times. This time it is not indecision, it’s on purpose. The great problem for our Nation is all of the change has caused the productivity model to be badly outdated.

Company leaders need to have an idea of how much materials, labor, transportation, and short term finance will cost before they can make their widgets. Health care changes the labor cost, They need to know material cost. EPA and regulation often changes that. Getting widgets to market goes up and down with oil prices, and since 2008 it has been nuts to get short term financing. With all of those unknowns, how many new hires would we make? What size production run would we OK? What price would we roll out to retailers?

Add to that the fiscal cliff and for another while I think you have paralysis. Depending on what gets worked out, the CEO/CFO can now consider a new tax model as a backdrop to running the business. BTW paralysis is not always bad, it’s better than death.

For the individual, I think it depends where you are with your life plan. There will be changes, the flow of capital will respond to the new rules. As the money changes direction some opportunities will open while others close. Some industries thrive while others wither.

Politically we have chosen not to use our resources to create wealth in the USA. Energy, ore, timber, labor…all of these and more have been foresaken. This makes us a debtor nation, simply because we have decided it’s better to buy from the other guy than produce domestically. Eventually, this will catch up to us. If it becomes too risky to own lots of USD the foriegn makers will no longer desire our markets

The fiscal cliff impacts that issue too. How the govt manages it’s debt, how much of the world credit it soaks up changes available credit for everyone else. Unless, we just print more money. But that effects the desire to own USD worldwide.

And so we have a group of people that are mostly preoccupied with the next election considering these issues. We will all have to wait and see what they come up with.

Personally, I think using our resourses and growing out of the problem is the right answer. Trouble is, there is no political support for going that way.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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