Tuesday, December 4, 2012

Nancy Pelosi and the Dismal Science

Arguably the most interesting quote springing from our nation's capitol over the past several years was the now infamous Nancy Pelosi's remark on Obamacare:  "We have to pass the bill to find out what's in it".  Poor Nancy was ridiculed for a comment that, ironically, may have shown great insight into the inner workings of our federal government.

She's now at it again, but in a more subtle context in offering her guidance on the Fiscal Cliff.  We're paraphrasing, but it was something to the effect of "we all know what needs to be done: raise taxes, promote growth and cut spending".  We could hear the snickers from economists as this seemingly bipartisan but economically paradoxical statement was offered.  What Nancy failed to grasp is what every Econ 101 student learns, that higher taxes and lower spending do not produce growth, at least not in the short term.

The fiscal cliff, as we are calling it, is thus a choice between austerity and stimulus.  Since our fiscal stimulus cannot be paid for from revenue, it is also a choice between austerity and debt.  To avoid the cliff in its fullest sense, would therefore require postponing (yet again) the measures to which gave its rise.  This would mean reauthorizing the Bush era tax cuts, the payroll tax cut, capital gains and estate tax provisions, while kicking the can down the road further on spending cuts, by postponing the sequestration measures. 

This solution would cause the least fiscal drag in the short run.  Essentially, the fiscal cliff would be resolved with no more fanfare than the Y2K problem.  The concern, though, is that by punting our fiscal issues down the road it will magnify them in the long run, as deficits continue to spiral out of control.  The equity markets would like rally on the news, however, as many have suspected the market to be trading for quite some time more on government intervention than economic fundamentals.

The other extreme solution is to do nothing.  This would produce the greatest short term negative impact on the economy, but also slice the federal deficit in half in one-year.  This would also likely cause a deeply negative reaction in the stock market.

The argument that's ensuing in Washington, then, is between taking on some fiscal discipline in the form of higher taxes, per the Democrats' position, or in lower spending, per the Republican platform.  Our bet is that the cliff gets resolved in favor of neither.  Responsibility will give way to practicality.  Politicians despise austerity: even if they know it to be prudent, no one has ever been reelected on it.

The problem is, Nancy, you simply can't have it both ways.