In a press conference on Tuesday, Federal Reserve chairman Ben Bernake announced that the Fed would will spend $45 billion a month in buying long-term U.S Treasury bonds while spending $40 billion a month in mortgage bonds in an effort to keep interest rates near zero until unemployment drops below 6.5%, keeping in line with the Federal Reserve’s dual mandate. That should work, as low interest rates encourage borrowing and spending, leading to greater consumer demand and economic growth. Note, however, that the key word is “should”. Shortly after, Bernake warned that the Fed would be powerless to stop the devestating effects of the U.S going over the fiscal cliff, which brings us back to the political battle being waged in Washington, where 535 congressmen hold the economic future of the United States in thier hands. Of course, despite reassurances from both Republicans and Democrats that a compromise would be reached, once again a divided Congress is at a standstill, and with the clock continuing to tick, another recession is becoming a real possibility. However, before we get into the meat of things, let us ask ourselves this question; what is the fiscal cliff? The term fiscal cliff refers to expiration of Bush tax cuts, which were signed into law in 2003 and extended by President Obama in 2010, and across the board cuts in federal programs as part of the terms of the Budget Control Act of 2011, which was passed to allow Congress to raise the debt celling. Studies have shown that the tax increases could be as much as $412 for those making $20,000 or below, $1,231 for those making between $20,000 and $40,000, $1,981 for those making between $40,000 and $64,000, $3,540 for those making between $64,000 and $108,000, and $14,731 for those making between $108,000 and more. Going over the fiscal cliff would also see the end of the payroll tax cuts, tax breaks for busniesses, the beggining of new taxes as a result of Obamacare, and the expiration of federal unemployment benefiets. There will be across the board cuts to every federal government program and department, including the Department of Defense, with the exception of Social Security, Medicare and Medicade, as those are guranteed federal government porgrams and are thus expempt from budget cuts. These measures are similiar to the austerity measures seen in Greece, Portugal and Spain, and if they take effect here, then we may very well enter another recession, yet it seems that someone in Congress does not care.
Upon winning re-election in November, President Obama announced that reaching a compromise on the fiscal cliff was at the top of his agenda. Both parties, it seems, have come to an agreement with regards to federal spending, while President Obama and the Democrats have even supported extending the Bush tax cuts for the middle class. So, what’s the issue? In a meeting between President Obama and Republican House speaker John Boehner at the White House last Wednesday, both sides proclaimed that no progess was made on negotiations. The reason? Tax breaks for the wealthy. This standstill can be traced when Grover Norquist had just about every Republican in both the House and the Senate sign a 20-year pledge where they vowed to never raise taxes on any busniess or individual in the face of Obama’s election. In 2010, the last time we faced fiscal cliff negotiations, Obama, facing a re-election campaign, acquised to Republican demands and extended the Bush tax cuts. However, with re-election secured, Obama is insistent that tax increases on the wealthy take part in fiscal negotiations, and the Democrats and the Senate have adopted the same iron resolve. Republicans, it seems, have adopted the same iron resolve as well, with Republican South Carolina Senator Lindsay Graham even threatning to refuse to raise the debt ceiling if negotiations don’t include tax breaks for the wealthy. With this in mind, let’s explore the most likely scenario as we will go over the fiscal cliff. First, our Consitution grants the authority to levy taxes soley to the House of Representitives, and, considering that Republicans have adopted an iron resolve towards preserving tax breaks for the wealthy, any plan that comes from the House will likely include an extension of the Bush tax cuts. Now, let’s say a few Democrats in the Senate are willing to compromise, chances are the plan would get the 60-40 majoirty needed to pass through the Senate and reach President Obama’s desk. However, considering President Obama’s iron resolve, he will just veto the plan, and it is highly unlikey that Congress will get the two-thirds majority needed to overturn the veto. There will be no deal before January 1, 2013. We will go over the cliff, and the consequences will not be pretty.
One only has to take a holiday cruise to Greece, Spain, and Portugal to see the misery and suffering that austerity causes, and we will see the same here in the U.S when we go over the fiscal cliff. However, the recession won’t be caused by the spending cuts or even tax increases on the wealthy, but because of the tax increases that the working and middle class will face. Now, a recession is usually caused by a huge drop in consumer demand, and that will likely happen with the resulting tax increases on the working and middle class. Once this happens, the Federal Reserve will be faced with two difficult choices; they could either contract the money supply, and hope that raising the value of the dollar will drop the prices of goods in the market, thereby possibly increasing consumer demand, or they could continue to offset the effects of the recession by printing more money and pumping it into the economy while continuing to buy U.S Treasury bonds to keep interest rates low. If Bernake and the Fed choose the first choice, the result will deflation. Though the value of the dollar may increase, the loss of capital from the Fed limiting the money supply will likely force small busniesses to cut costs and lay off workers to adjust to the smaller supply of capital avaliable. The result will be unemployment at levels worse then those we saw in January 2009. If the Fed decides to go with the second choice, the result will be inflation. The value of the dollar will begin to fall and the price of goods on the market will begin to rise while wages stay the same. The Fed’s efforts to keep interest rates low by purchasing U.S Treasury bonds will be futile since consumer demand will continue to decline as a result from the inevitable rise in prices as a result of inflation. The result will likely be increased poverty as well as an overall decline in living standards for the average American. But that’s not all, it gets worse. With the U.S due to hit the debt ceiling in February 2013, Republicans will likely be fuming at the tax increases on the wealthy and may follow through with thier threat on refusing to raise the debt ceiling, the U.S will have to default on the national debt and declare bankruptcy. Now, the U.S national debt consists of about $5.8 trillion dollars owed to foregin nations, $4.8 to the Federal Reserve, and the rest to private banks and individuals. Your entire life savings could be lost since banks hold U.S Treasury bonds, and chances are you keep your money in a bank account, which is ultimatley invested in a U.S Treasury bond. Many U.S firms will become nationalized in forgein nations while the U.S exports will have tariffs slapped on them. The loss of forgein markets will cause busniesses to close shop and unemployment will soar. The value of the dollar will likely drop and lose it’s privilige as the world’s reserve currency, thus leading to inflation, increased prices of goods and commodities, and even more poverty. This is why we can’t go over the fiscal cliff, but it seems like someone’s content on doing it anyways. So, who’s to blame?
To answer the question above, it is, quite bluntly, the Republicans fault if and when we do go over the fiscal cliff. Since Obama’s re-election, he and the Democrats have shown to be perfectly willing to negotiate and even acquisece to Republican demands on cuts to federal spending. Yes, the Democrats are adopting the same iron resove with regards to taxation as the Republicans, but, who can blame them; they don’t work. Quite simply, tax breaks for the wealthy go against fundamental Keneysian economics as they place the burden of taxation on the middle class, reducing consumer demand, while inhibiting the government’s ability to stimulate an increase in consumer demand by increasing spending on infastructure, education etc. Even if you don’t believe that, countless studies by non-partisan tax agencies have shown that tax breaks for the wealthy just don’t work. They are bad economics all around. Yet, in the face of all these facts, Republicans are still clinging onto a failed policy, and it could just be deadly as it will prolong that standoff in negotiations that will likely see the U.S go over the fiscal cliff.