European solution for the fiscal cliff

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US Fiscal Cliff
US Fiscal Cliff depicted in a cartoon. Image credit: http://worldpoliticaleconomy.com

As soon as the deal was reached in the Eurozone crisis on Greece, there was a strong sentiment towards the realization that a deadline had been averted and a new life had been breathed into the Greek economy. There is a still a need to realize that this deal was not easy and that serious measures had to be taken by all parties to show that everyone had their skin in the game. The austerity measures put into place were not popular among the people but it was still a bitter pill that had to be swallowed to lead to this. Even though the crisis has just been delayed, it still means that the Greek economy is afloat for a few more years.

The situation in America seems to be similar. The political deadlock that is seen in Congress is just like the political opposites that Europe had and that both sides were not willing to let go of their leverage situation that they hold. Many within the markets feel that the fiscal cliff would be averted as there is too much riding on it. The rise in taxes and the reduction in spending is the last thing that the economy needs as it is finally trying to get back on its feet. Other feel that the partisan leadership is too divided to be able to take a step and feel that the lethargy on Capitol Hill will not gather enough momentum to lead to a change.

The third option is that the US sits back and lets the fiscal cliff take place. But is that a bad thing? Greece, Portugal and others in Europe have already taken the unpopular step of enforcing the austerity measures. Even though people did not like it, it still showed that they were aware of the problem and willing to work towards a solution rather than pander to its people till the next election. If the same happens in the US, it will show the markets that US is willing to take the riskier and more drastic measures and would rather choose a long term solution this time round.

Last year, the same situation was apparent and a delay of one year was agreed upon within which measures would be enacted to deal with the deficit and debt. That has not taken place. The Republicans now need to see some cuts in the welfare program to make government reign in on it’s out of control spending. On the other hand, the Democrats also want the richest to pay higher taxes in order to bridge the deficit from the other end as well. Wealthy and affluent Americans are willing to take the hike in taxes like Warren Buffet rather than see a uniform rise in everyone’s taxes across the board.

What a fiscal cliff would lead to has three key impacts on the whole. Firstly, the fiscal cliff will end the trump card that both Republicans and Democrats hold at this stage by taking it away from each other. Secondly, the cut in spending and rise in taxes would be temporary and marginal in case of a deal at this stage. Maybe it’s time for the US to handle this issue once and for all and carry out the necessary adjustments rather than delay it further. Lastly, the markets and the dollar are taking a hit against the euro in the last few days. The equity and debt markets also look sceptical while US is losing its ratings in the bond markets.

By going over the cliff, the debt rating would rise for the US as it will improve its image, the currency would go through a drastic fall but it will reach the point it should be at rather than being volatile until the 1st of Jan. The equity markets are also on the fence regarding this issue and letting it happen would put them all on one side.

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