As the clock winds down on 2012, the
Fiscal Cliff is all anyone seems capable of discussing. Right now it appears
that some sort of narrow deal has just emerged that will include raising tax
rates on family income over $450,000 a year, increasing the estate tax rate,
extending unemployment benefits for one year, and delaying spending cuts. But
the prospect of higher taxes and the great uncertainty that has surrounded
this fiscal fiasco has been acting like sand in the gears of the complex but
sputtering U.S. economy. If additional taxes are not matched by real cuts in
government spending, the economically crippling tax increases will serve
merely to increase the size and intrusive power of big government. In other
words, the pain will yield no gain.
But the damage to the U.S. economy will
result not so much from the actual cuts and tax increases that the Cliff
would involve, but from blatant dereliction of duty on display in Washington
which will diminish national prestige.
To some, a loss of reputation may seem
to be an ephemeral and ultimately insignificant economic cost. However, the spectacle
of American politicians failing to agree on budgets, spending limits, or any
type of fiscal discipline can affect the credit rating of the U.S. Over the
longer term, a major fall in the credit rating is likely to increase U.S.
interest rates. This would add further to the pressure on U.S. debt and
render the U.S. Treasury bond market as one of the greatest financial bear
traps in history.
Even more threatening than the Fiscal
Cliff is the far higher and steeper Entitlement Cliff, which dwarfs the Fiscal
Cliff in almost every dimension. America's massive baby boom generation began
entering retirement last year. As increasing numbers of workers retire over
the next decade, significant strains will be placed on Social Security and
Medicare, America's entitlement monoliths. It is no understatement to say
that if the finances of these programs are not brought into balance, the
United States will be brought to its knees financially. Yet both parties in
Washington appear content to ignore these problems. A very modest proposal by
Republicans to trim Social Security expenditures (by cravenly tinkering with
inflation calculations) was withdrawn almost as soon as it was introduced.
But in truth, anything short of a
comprehensive resolution of the Entitlement Cliff threatens to sap the
economic prospects of the United States for generations to come. At present,
however, the U.S. dollar, despite its inherent fatal flaws, continues to be
perceived by many as the 'currency of refuge'. In contrast, the euro, although
protected somewhat by central banks, does not enjoy the full status of an
international reserve currency. Therefore, the Eurozone has been forced by
the financial markets to jump off the cliff and endure economic austerity.
This privileged position has conferred
on Washington the vital element of time to organize viable revisions to its
entitlements. As a result, plans could be made to coordinate the
restructuring and reduction of government spending, borrowing and taxation. A
wise government could be looking to make an orderly descent from the top of
the cliff, making provisions for solid footing and safety lines. But alas,
this opportunity has been left unexplored.
Though a short-term fix may have been
reached, the Entitlement Cliff still looms large and descending down this
precipice could seal the fate of the U.S. dollar. As a result, the ability of
U.S. politicians to deal with entitlement spending will have global economic
consequences of the highest order.
The shockwaves of miscalculations if
made by American politicians could reverberate around the world, affecting
international financial markets and threatening the continued viability of
fiat currencies.
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