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4 Problems Bigger than the Fiscal Cliff

The fiscal cliff would at least sort out the deficit...

EVERYONE'S worrying about the damage the "fiscal cliff" might do to the US economy in 2013, writes Martin Hutchinson for Money Morning.

But the reality is that's only one of the potential problems in our 2013 US Economic Forecast. 

At present there appears to be four problems – aside from the fiscal cliff – that could throw the US economy into recession in 2013. 

These are international problems that include:

  • Brewing trouble in Japan: Japan faces an election next month. More importantly, its government debt is currently 230% of GDP, with that ratio rising by about 10% a year. The current government has increased sales tax in 2014, which may cause a recession and will likely push its debt to GDP ratio even higher. The problem is no country has ever survived a debt/GDP ratio above about 250% without defaulting. Britain did succeed with this in 1815 and 1945, but on the second occasion it relied on exchange controls, inflation, and dozy domestic investors, while on the first occasion it had a government under Lord Liverpool far more capable than anything we have seen in the last 185 years.The point is, if Japan gets a weak coalition after its election, the market may panic and cause a Japanese government default. 
  • More Woe in Europe: The Eurozone mess continues and is getting worse rather than better. Investors are just beginning to wake up to the fact that France, by exceptionally foolish policies of fleecing the rich, has put itself in a position that may well prove worse than those of Italy or Spain. The Eurozone crisis is soluble - by the weak sisters leaving the Euro - but this solution is unacceptable to the EU political elite, so we may get a crisis, a major default, a European banking collapse and deep recession instead.
  • Troubles in the BRICs: All four of the BRICs are reaching the end of the road in terms of economic growth. Having had the world's money thrown at them like confetti, they have used it to grow government and reward themselves through an orgy of corruption. China's problems are hidden in its banks' balance sheets. India needs a government that does not overspend (fat chance!), as does Brazil. As for Russia, its military will soak up all its gigantic oil revenues and its leaders will embezzle any money the Western banking system is foolish enough to lend it. These crises will worsen in 2013. At some point they will combine into a gigantic BRIC crash, affecting the whole world economy
  • Iran, Israel, and the Middle East: Either Iran will get a nuclear weapon in 2013 or Israel will go to war to stop it. Either way, it's bad for the world economy; the only question is how bad.

As for the fiscal cliff, the problem is that the package of "cliff" policy changes involves mostly increased taxes, so they will cause a recession of their own. That would, however, be salutary. 

Since we do not currently have a banking crisis and have not levered ourselves up too far, an early recession would be fairly short and uncomplicated, and at the end of it we would more or less have solved the federal deficit and debt problems. 

So, we should welcome this particular "problem" and hope the politicians don't manage to avoid it.  

Should the politicians avoid the fiscal cliff, most likely by putting taxes up on high incomes while leaving most of the budget deficit in place, the short-term prognostication isn't all that wonderful. 

US economic growth has been held back in the last few years by the blizzard of regulations coming out of Washington, and there's reason to believe there is an especially heavy storm of them coming in the next few months, having been held up before the election. 

Thus, no matter much money Ben Bernanke creates, the US economy is not going back to robust growth in 2013. Creating more money will just increase inflation, and together with the continuing budget deficit will suck capital out of the US towards our creditors such as China and Japan.

In the long run, a recession is coming, like it always was. With bad policies in place worldwide, that recession will almost certainly be less painful if we get it over quickly, and don't delay it into 2014 or later. 

After all, with each year that passes under the current policies, the level of foolish investments in the financial system increases, so a delayed recession might well involve another financial crisis, like 2008 - and we've seen how much fun that was.

Overall, 2013 looks like a rough year for the economy. Gold and stocks in well-run emerging markets (of which there are only a few) seem to be the best safe havens.

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Now a contributing editor to both the Money Map Report and Money Morning, the much-respected free daily advisory service, Martin Hutchinson is an investment banker with more than 25 years’ experience. A graduate of Cambridge and Harvard universities, he moved from working on Wall Street and in the City, as well as in Spain and South Korea, to helping the governments of Bulgaria, Croatia and Macedonia establish their Treasury bond markets in the late '90s. Business and Economics Editor at United Press International from 2000-4, and a BreakingViews editor since 2006, Hutchinson is also author of the closely-followed Bear's Lair column at the Prudent Bear website.

See full archive of Martin Hutchinson.

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