What is it?

A few years ago the US Government enacted a number of tax cuts. These cuts, as fate would have it, expire at the end of 2012. At the same time it is legislated that the US Government must cut trillions of dollars from its spending over the next few years, beginning in 2013. It is feared that the combination of expiring tax cuts and spending cuts will send the US economy into recession.

Why would they let this happen?

Simply speaking, the tax cuts were put in place to stimulate the economy and, at the time, 2012 seemed such a long time in the future that the politicians thought setting an end date of 2012 would not pose a problem and if it did, the measures could be simply extended.

So why don’t they just extend the measures?

Now we are getting to the crux of the problem! Everyone in the US Government knew the fiscal cliff was coming but they did not want to do anything about it until the US election was done and dusted. Now that we know the result of the Election, focus has shifted to the fiscal cliff.

Governments, like everyone else, operate on a budget. In the US, the Government spends far more than it earns (i.e. receives in taxes) and is running a large deficit. Next year when the changes come into effect it is expected that the deficit will be greatly reduced.

Hence the reluctance to rubber stamp an extension – the Government must balance its ballooning deficit with the possibility of significantly reducing it via the expiry of tax cuts and spending cuts.

So what will actually happen?

Nobody wants the fiscal cliff to come to fruition but, as we know, bad news sells, and it makes a great headline to tout the end of world via a fiscal cliff!

What I expect is that we will see US politicians on both sides of the fence grandstanding over the next few weeks, saying that they alone have the solution to the problem which will save the world. While this will go on right up until the 11^th hour, I expect that a deal will eventually be struck to either extend the measures or soften the cuts – effectively kicking the can down the road to be dealt with at a future point in time (… sounds familiar!)

The downside to all this is that it will breed uncertainty in the share market, and if there is one thing the market hates it’s uncertainty. Expect a volatile next few weeks as ideas and solutions to the fiscal cliff are bandied about and feverishly debated.

Hopefully once all this is over we can begin 2013 afresh and focus on a good year of market growth.