The Real "Fiscal Cliff"

The Real "Fiscal Cliff"

By Jack Kelly - December 10, 2012

What will happen if we go over the fiscal cliff?

That depends on which "fiscal cliff." The term has been applied to two very different economic events.

Journalists now are calling the "fiscal cliff" what will happen in January if Democrats and Republicans in Washington don't make a budget deal this month:

• Income tax rates will revert to what they were before President George W. Bush cut them.

• "Sequestration" -- the $1.2 trillion (over 10 years) in automatic spending cuts that Congress agreed to as part of last year's debt-ceiling deal will begin.

• The "temporary" 2-percentage-point reduction in payroll taxes for Social Security and Medicare will expire.

The combination of these tax hikes and spending cuts would raise unemployment back above 9 percent and plunge the economy into recession, the Congressional Budget Office has forecast.

That's bad. But if the economy falls over this "fiscal cliff," it's likely only to sprain an ankle or maybe crack a rib. If the economy goes over the much higher cliff to which the term originally referred, it could break its neck.

When a nation's debt exceeds 77 percent of its gross domestic product, it exerts drag on economic growth, wrote economists at North Carolina State University in a 2010 study for the World Bank. When debt exceeds 90 percent of GDP, economic growth is cut in half, according to economists Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard in a 2012 paper.

The original "fiscal cliff" was the point at which the burden of debt gets so heavy that it triggers a financial collapse. Many of the 66 countries Ms. Reinhart and Mr. Rogoff studied for their 2009 book, "This Time it's Different: 800 Years of Financial Folly," have gone over it.

That point has varied from country to country, age to age. We're likely to find out soon what ours is. In 2007, our national debt was 65.2 percent of GDP. In the five years since, the economy has grown 16 percent. But debt has grown 82 percent. Total debt now exceeds 100 percent of GDP.

The "official" national debt is just the tip of a very large iceberg. It doesn't include unfunded liabilities for Social Security ($20.5 trillion), Medicare ($42.8 trillion) or pensions for federal workers ($5.8 trillion). State and local governments owe an estimated $4.2 trillion, much of it for the pensions of public employees.

Private consumer and corporate debt has declined substantially since the subprime mortgage bubble burst, but, at 260 percent of GDP, remains dangerously high. (Private debt was 240 percent of GDP in 1929.) Excessive private debt is the main cause of recessions and depressions, according to a 2012 paper for the National Bureau of Economic Research.

We're borrowing less for home mortgages and auto loans, and we aren't charging as much on our credit cards. But student loan debt is soaring.

"We can't expect real economic recovery, or even to remain stable at the precipitous level of economic stability we have now, if more and more people are putting the majority of their income toward paying off student loans rather than stimulating the economy," wrote Lilly O'Donnell for Policymic.

The "official" national debt will grow by $1.5 trillion during President Barack Obama's second term, CBO estimates. But according to a study by the Federal Reserve Bank of St. Louis, CBO wildly underestimates the size of deficits, so bet on it being much more than that. Unfunded liabilities in Social Security and Medicare will soar as more seniors retire and fewer young people can find work.

The day of reckoning is near, say economics professor Nouriel Roubini and investment strategist Peter Schiff, two of the handful who forecast the bursting of the subprime mortgage bubble.

What's coming will be much worse than 2008, they say. The carnage on Wall Street will resemble 1929. The economy will contract sharply. Unemployment will approach -- and may exceed -- Great Depression levels. Rampant inflation will wipe out the savings of the middle class. Some state governments will follow many municipalities into bankruptcy.

Our toes dangle over the edge of a mountain of debt. That's the fiscal cliff we should worry about.

Jack Kelly is a columnist for the Pittsburgh Post-Gazette and The Blade of Toledo, Ohio.

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