By Andrew Nelson
There has been increasing talk in the market and in our service about the US economy heading towards a "fiscal cliff", with the current presidential election seen by many as the lynch pin. Yet many still ask: what is this so-called fiscal cliff, why is it so important to global markets and what happens if the US, like Thelma and Louise, drives right over the edge?
First, let's start off with a definition. The "fiscal cliff" is a term of phrase coined by US Federal Reserve Board Chairman Ben Bernanke and it refers to the prospect of automatic, year-end US Government spending cuts and tax increases.
The reason we fear the approach of the fiscal cliff is due to the current political situation in Washington. Democrat President Obama has proposed several budgets, but has been blocked at every turn by a Republican-dominated House of Representatives. Unlike Australia, where a government's failure to pass a budget results in a speedy election, a blocked budget in the US means the US Government stops writing cheques until something has been passed.
It is hoped that the upcoming election in November will provide the US a chief executive and house majority of the same party. That way, Washington avoids at least another two years of political stalemate, with there being a good chance that some sort of budget will be approved. Put more implicitly, one party winning the presidency and lower house will remove uncertainty, and we all know markets hate uncertainty. Given the odds are on the Republicans keeping their majority in the lower house, US markets are firmly behind a Romney victory. There are also myriad political, economic and philosophical rationales for this preference as well, but we'll not delve into them here.
A new paper from BlackRock Investment Institute, entitled US Election Cliffhangers, takes a look at some of the most likely scenarios for the November 6 US election, and the findings are quite sobering.
The first and main problem BlackRock sees is a "dangerous disconnect" between professional investors and Washington experts. The company recently sat down with a number of Washington insiders and the consensus is that political dysfunction will indeed push the nation off the cliff. However, it is believed the drop will be a short and sharp one, ultimately providing politicians the necessary