What now with the “Fiscal Cliff?”

So I explained what the fiscal cliff is and why it is bad, but what will ultimately happen?  I have no idea, trying to figure out what a bunch of politicians are going to decide seems like a fool’s game.  Who can predict that?

Still, what we can try and do is estimate probabilities.  Now, I am not a forecaster, but I can give you the good news – the CBO says the forced austerity would probably throw the economy into recession.

Why is this good news?  Well the severity of going over the“fiscal cliff” is severe, so my thought is reason will dictate the discourse and if reason fails there is the insurance that these politicians like to keep their jobs.  I would actually bank more on the latter.   

Further, the two big items are the Bush tax cuts expiring and the “sequester”, there seems like a natural compromise here.  Republicans get the tax cuts, Democrats get to push back the automatic spending cuts.  Maybe the stimulus measures don’t get renewed, but hopefully the Bush tax cuts staying and "sequester" leaving will be enough to keep this 2% growth train moving!

Here is how Goldman Sachs econ team handicaps it:

1. 35% chance of temporary expiration of growth policies in 2013
2. 40% chance of short-term extension of growth policies with longer-term solution in later 2013
3. 20% chance of extension of growth policies for more than a year
4.  5% chance of “grand bargain” of fiscal and tax reform

The problem with the above (as with Europe) is that temporary measures are just that and create even more uncertainly.  Still, the above paints a 65% chance of outcomes I believe would be intermediately (through Q2 2013 maybe) good for the market, of course absent any exogenous shocks.

At the end of the day, I think the “fiscal cliff” big risk parallels another one of my big risks – Europe.  That is to say, the severity of the situation should yield at least a semi-positive result (I hope).  Still, the risks are large, real, and should be met with caution.  My other big risks are much harder to handicap – war Iran (seems low, but who knows) and a Chinese hard landing (black box).