Time to brace for crash

Saturday, January 5, 2013
By Paul Martin

By Martin Hutchinson
Jan 5, 2013

The US public is unprecedentedly pessimistic about the prospects going into 2013, with 56% “fearful” against 40% “hopeful” according to a recent Washington Post-ABC News poll. When one looks at the world’s markets, and at the policies that have been almost universal since the crash of 2008, one can see the rationale for their pessimism. However this column wishes to inject an element of cheer into the conversation: with good luck, given a continuation of current policies, it may be 2014 before an almighty market and economic crash occurs!

One event that will not itself cause a crash in 2013 is the much-feared “fiscal cliff”. If this goes into effect and is not reversed, it will reduce the US federal deficit by about US$700 billion per annum, to a level of around $300 billion. By reducing interest rates, this will stimulate interest-rate-sensitive areas of the economy, providing purchasing power to offset that withdrawn through higher taxation. The result will be a dip in output that lasts a few months, probably not long or steep enough to qualify as a recession. That will be followed by recovery on the basis of an economy with lower consumption, a smaller balance of payments of deficit and stable public finances (assuming House Republicans can prevent any counterproductive and wasteful “stimulus” spending programs).

If the “fiscal cliff” is allowed to take effect, the problem will arise on the monetary side. Ben Bernanke will continue pouring $85 billion per month into Treasury and Agency bonds, over $1 trillion a year, but the demand from the Treasury will have been reduced to only $300 billion annually. With $700 billion being poured into the economy with nowhere to go, inflation will take off, initially through the commodity markets and internationally, but quickly pouring into the US economy also.

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