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The Only Thing You Need To Know About The Fiscal Cliff

 December 07, 2012 11:01 AM


I'm going to lay out everything you need to know about the fiscal cliff negotiations. After reading this, you can ignore all of the media's coverage of this topic as well as various politicians' announcements pertaining to this subject.

All you need to know consists of just one sentence.

Politicians are in charge of this issue.

These are the same folks who haven't even produced a budget in four years. The same folks who have run $1+ trillion deficits for four years. The same folks who rarely if ever leave office as a result of their fiscal mistakes.

In simple terms, none of the people in this group will likely suffer any consequences if we do go over the cliff. Indeed, as far as options go, their best option would be for us to go over the cliff and then implement some targeted tax breaks in late 2013 early 2014 as they go into the 2014 Congressional elections.

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Let's take the side of the Democrats.

Obama was largely re-elected based a solid turnout for the Democrats and a lack of voter turnout for the GOP. If you want to argue about voter fraud the fact remains that if there was widespread voter fraud the GOP let the Democrats get away with it. So for simplicity's sake, Obama won based on a strong turnout while the GOP lost based on a weak turnout (Romney took less votes that McCain!).

With this in mind, Obama and the Democrats can easily argue that they have the mandate of the people for their policies. If the GOP proves unwilling to go along with their proposals, Obama and the Dems can simply take us over the cliff, increase taxes on the wealthy (which would appease their voting base) and blame the failure to reach a solution as well as the ensuing economic mess on the Republicans (much as the Dems and Obama have blamed the terrible economy on Bush).

[Related -ETF Performance Review: Major Asset Classes | 19 Dec 2014]

So, truth be told, Obama and the Dems really have very little to gain politically from solving the fiscal cliff.

On the GOP side, there is little incentive to solve the fiscal cliff either. If they kowtow to Obama's wishes, they'll infuriate their base. And there's no chance that they'll convince Obama and the Dems to meet their demands of cutting spending (they sure haven't done anything of this nature in the last two years). So the best thing they can do is simply refuse to address the problem, go off the cliff and then maintain a "we fought the best we could against insurmountable odds" stance.

So… neither the Dems nor the GOP are incentivized to solve the fiscal cliff.  Both parties are best off from a political standpoint having us go over the cliff and then fighting for some kind of tax breaks/ tax relief for their bases sometime in late 2013/ early 2014.

With that in mind, we're very likely going over the cliff in a month's time. The whole situation has echoes of the failed debt ceiling talks and subsequent market collapse of 2011.

Indeed, the market's action today looks virtually identical to its moves going into the Debt Ceiling talks in July/August 2011.

Here's the S&P 500's recent action:

Here's what the market looked like going into the Debt Ceiling talks of 2011.

Here's what followed:

I highly suggest preparing in advance.

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