For all the worry, the fiscal cliff was just a preview of the debt-ceiling ruckus ahead. Here's why that could be worse for investors-and how to get through it, counsels MoneyShow's Jim Jubak, also of Jubak's Picks.
You ain't seen nothin' yet.
The cliffhanger of a fiscal cliff deal was just a dress rehearsal for the
late-January/early-February battle over raising the debt ceiling. This time it's
worse-and more worrisome for investors. This one could really move
global markets-and move them fast and hard, in the not-so-distant
Here are three reasons why, plus a strategy for getting past it.
The Crises Ahead
This time the damage from missing the deadline for a deal sets in on Day One. The negative effects of not reaching a fiscal cliff deal on taxes and spending on Jan. 1 or thereabouts was never going to be immediate. In the fiscal cliff crisis, tax rates indeed would have gone up immediately, but tax payments would have increased gradually and spending cuts would have been phased in over time. The damage to the US economy from a fiscal cliff failure would have been major-perhaps enough to send the economy back into recession-but it would have been felt only gradually. That's why economists, Wall Street pundits, and politicians kept saying that it was possible to go over the cliff and still fix the problem before the economy suffered major damage. (This was the so-called bungee-cord strategy.)
That's not true of the debt-ceiling crisis. This time, the damage is likely to be big and immediate, and some of it won't be easily reversed.
This crisis is really three crises in one:
- Crisis No. 1 is the raising of the debt ceiling. If Congress doesn't raise the current $16.4 trillion debt ceiling, the Treasury can't increase net borrowing to pay the country's bills. In practice, the Treasury has ways to manage the country's debt levels so that it can pay US obligations until, according to estimates from the Congressional Budget Office, mid-February. After that, the Treasury would have to decide to pay some bills and not others. You can bet it would continue to pay the interest on US debt, even if it had to raid other budget lines to do so. Default on US debt obligations would throw the US and the rest of the world into financial market chaos.
- Crisis No. 2 hits shortly after the Treasury runs out of room to finagle. The fiscal cliff deal put off $1.2 trillion in automatic spending cuts divided equally between defense spending and domestic discretionary spending-this is what's called the sequester-that were set to gradually take effect after Jan. 1, according to the terms of the Budget Control Act of 2011, which ended the most recent battle over the debt ceiling. (About $100 billion in automatic cuts would go into effect in the 2013 fiscal year that ends on Sept. 30.) The Jan. 1 fiscal cliff deal postponed the cuts until March 1. So, sometime in the next six to seven weeks, Congress will have to resolve the automatic budget cuts it has failed to address in a meaningful way in the past 18 months or so. Otherwise, federal spending gets whacked by $100 billion this year-with more cuts to come. That's certainly enough to take a bite out of first-quarter growth in gross domestic product that economists already fear could dip to a rate of just 1%.
- Crisis No. 3 comes close on the heels of Crisis No. 2. The September 2012 continuing resolution that authorized spending by the federal government expires March 27. Unable to pass an actual budget or the appropriation and spending bills that go with it, our government in Washington has been operating under a continuing resolution that authorized spending for the first half of fiscal 2013. Unlike a failure to raise the debt ceiling-which would lead to the government paying some bills and not others-failure to extend the continuing resolution would mean that the federal government wouldn't have authority to spend any money. Here, we're looking at something that would actually shut down the federal government.
The two sides have already begun to double-down on their rhetoric. Congressional Democrats, afraid that President Barack Obama will negotiate spending cuts on entitlements including Social Security and Medicare, are urging the President to get tough. House Minority Leader Nancy Pelosi, D-Calif., has said the President should invoke the 14th Amendment to raise the debt ceiling by presidential order. Section 4 of that amendment says, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned." Some constitutional lawyers-along with some Congressional Democrats and some members of the Obama administration including Treasury Secretary Timothy Geithner-have argued that this language makes the debt ceiling itself unconstitutional and gives the President the power to simply raise or ignore the debt ceiling. (So far, the White House, aware that such an assertion of power would provoke a constitutional crisis, has said it does not intend to invoke the 14th Amendment.)
On the Republican side, Senate and House leaders facing a revolt by conservative Republicans have declared any further tax increases off the table. On Sunday, Republican Senate Minority Leader Mitch McConnell of Kentucky said, "The tax issue is finished, over, completed." That will come as a surprise to a White House that is holding to its position that any spending cuts must be balanced 1-to-1 by tax increases. Such extreme positions seem to mark the beginning of negotiations in Washington these days. And the distance between these positions, even if they are rhetorical posturing, is certainly enough to make reaching any agreement a long and drawn-out affair with big potential to worry the market.