Fiscal cliff still in view for Americans facing income and spending cuts

Recession in the US might have been avoided but stock market glee will fade and March could bring the start of $1.2tn cuts

It’s a triumph! The fiscal cliff has been avoided, US politicians have discovered the spirit of compromise and stock markets are booming. Happy new year.

Sadly, none of the above is accurate. First, the largest part of the cliff remains, since $1.2tn of spending cuts over a decade will start to be implemented from March if no further deal can be done. Second, it’s stretching credibility to conclude the bipartisan mood in Washington is softening; the compromise that will see income taxes rise slightly for the richest Americans is so modest that it could have been struck weeks ago without brinkmanship.

Third, the stock market glee requires context. A one-day rise of 2% or so in share prices is not be sniffed at but we’ve seen larger rallies greet overhyped “fixes” for the eurozone crisis.

These usually fade once investors reflect that the avoidance of an immediate calamity is not the same thing as a determined attempt by politicians to address an underlying debt problem. Reaction to the US fiscal fudge could follow the same script: near certain recession has been avoided, but that’s not much to shout about.

So fans of clifftop dramas should settle back and prepare for another episode as the March deadline approaches. Indeed, Barack Obama barely paused before warning Republicans that they’ve “got another think coming” if they believe spending cuts alone will be the focus of the next round of talks.

In other words, even the tax element of the tax-and-spending debate has not been settled definitively.

What’s more, negotiations ahead will be further complicated by the inevitable arrival of the US at its $16.4tn debt ceiling, the legal cap on government borrowing.

The new year deal did not contain a provision for an increase – the clearest illustration of how compromise was achieved only by ignoring the tougher issues.

It’s a case of out of the frying pan and into the fire, concluded John Ashworth, senior economist at the thinktank Capital Economics. “Given the cantankerous nature of the negotiations over the past 10 days, it is now very possible that we will see another standoff over those spending cuts and the debt ceiling that leads to a shutdown of the federal government by late February or early March,” he predicts.

That worry, it hardly needs saying, is unlikely to prompt cash-rich US companies to decide that this is the moment to increase investment and hire more workers.

Consumers will also be nervous; many now face immediate cuts in their disposable incomes because the less-heralded element of the deal was the agreement not to extend the temporary reduction in payroll taxes, the equivalent of UK national insurance contributions. For those earning $50,000 a year, it means a $1,000 cut in income.

Surely, it might be said, the political stakes are now so high and the confidence of US consumers so fragile, that a so-called “grand bargain” on tax and spending can be thrashed out at the second attempt. Don’t bet on it.

The missing ingredient in this drama is alarm in financial markets. The US can still borrow for 10 years at less than 2% (partly because the US Federal Reserve is buying US debt and other assets at a rate of $85bn a month), the dollar is relatively stable and the US economy is still growing.

As Richard Lewis, at the fund manager Fidelity Worldwide, puts it: “We are unlikely to see much change in behaviour unless or until serious dollar weakness calls time on Washington shenanigans.”

If the muddle-through option is still on the table in March – and it probably will be – don’t be surprised if the politicians again grab it. © 2013 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds

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