Many of you may have heard of the Fiscal Cliff but few people seem to understand exactly what this refers to or what it could imply. Here are some of the facts you need to know.
The end of this year will bring with it the expiration of tax cuts put in place by presidents Bush and Obama. At the same time there are also automatic spending cuts which come into effect. The expiration of the tax cuts alone could increase tax revenues by $400 billion while the spending cuts could remove in excess of $100 billion from the economy.
The reason these contracting fiscal measures are so ominous is that the US growth figures are presently fragile at best. The second quarter of 2012 indicated a 1.5% GDP Growth rate for the US. If the Fiscal Cliff should hit with full force it could remove an amount equalling approximately 4% of GDP from the economy. While this should substantially reduce the US deficit and go some way to reducing their staggering debt burden it will most likely drive their economy into recession.
This is important for the global economy and would place pressure on the other countries relying on the US demand for their export goods. This could spell trouble for China and the rest of Emerging Asia. Their export growth figures, while positive, are very low. With the Euro area already in a recession this could spell further trouble for the region.
Luckily though, these drastic spending cuts and tax-cut expirations are not a certainty. If the US House of Representatives, the US Senate and the House of Congress along with the US President can all agree to delay the spending cuts and the tax-cut expirations, these measures could be postponed until the economy is in a stronger position and better able to take the strain of fiscal contraction. However this is an election year in the US and the parties are unlikely to agree with each other – even on such important matters – before the election is over in November. This will leave precious little time during November and December for all parties to reach an agreement and to avoid pushing the economy over the “Cliff”.
Thankfully, it is not quite time yet to stuff your money under the mattress in anticipation of a global meltdown because despite the great uncertainty and shocking headlines, the world economy is still expected to grow at approximately 3% in 2012 with the outlook even more favourable for 2013.
For now there are still too many balls in the air and we are watching with great interest as events unfold. Whatever the outcome, we are still confident that a well diversified portfolio, invested with trusted asset managers with proven track records is the most prudent investment choice to grow capital over the long term while limiting the downside in the short term.
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