How the Fiscal Cliff will be resolved and who has the upper hand in the negotiations

There is a lot of analysis, opinion, and fantasies when it comes to any fiscal cliff discussion but what is almost universally agreed to, in principle, is that if we go over the cliff the US economy will likely experience a slowdown in 2013. There may be disagreement as to the severity of such a decline but there is near universal agreement that going over the cliff is negative for the economy. Starting from that point we can apply some logic and conclude how the fiscal cliff will likely get resolved.

When it comes to politics, it is fair game to assume that whoever is in the White House gets the credit, or the blame, for the performance of the economy regardless of whether this performance was a result of their policies or the normal cyclical nature of the economy. So it is fair to assume that if the economy goes into recession in 2013, or beyond, the White House and President Obama will be blamed for it no matter how “obstructionist” the Republicans are deemed in Congress. It will further cement the label given to President Obama (rightly or wrongly) that he is highly partisan and unable to work with others across the aisle.

It is said that in any negotiation whoever has the power to say “No” has the upper hand. Given that Democrats control the White House and the Senate and need the Republicans in the House to agree to any deal, the Republicans in this dynamic have the power to say no. Making your best offer, not budging, and having the other party walk away is the ultimate bargaining position if you have the luxury to be in this position. Right now, the GOP is in that position and, as I explained above, it is the White House and the Democrats who will get the blame in case of any recession in 2013. Any recession between now and the next mid-term elections in 2014 will likely cause Democrats to lose seats in Congress and not the other way around.

Because of this, I expect the Democrats to give more concessions and eventually reach a compromise deal that is satisfactory to Republicans. Until then, the market will be choppy and likely to remain under pressure until a deal is reached. Once a deal is reached, probably at the last minute but can be well into 2013, I expect a relief rally particularly if we had a decline in stocks in December and/or January.

See my other article on Fiscal Cliff impact on Stocks and Bonds

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Tagged Fiscal Cliff 2012