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Will the Fiscal Cliff Clash Damage the U.S. Credit Rating?

There are less than fifty days left for lawmakers to come to agreement on the fiscal cliff, but uncertainty surrounding the dilemma is already affecting the economy. The political bickering over solving the fiscal cliff issue now has put the U.S. AAA credit rating at risk again.

In early September ratings agency Moody's Corp. (NYSE: MCO) announced it would likely downgrade the U.S. credit rating if no deal is reached before the end of the year, and on Monday the company reiterated its stance.

"A scenario whereby action on the budget is delayed until sometime in 2013 appears increasingly likely; for example, via a temporary extension of most measures except the increase in payroll tax," Moody's officials said.

"Such deferment, if not accompanied by an apparent commitment to achieving agreement and a credible timetable for implementing the necessary reforms to preserve sovereign creditworthiness, would be inconsistent with maintaining a AAA rating," they warned.

Fiscal Cliff Bickering Must End

Due to the higher taxes and automatic cuts that come with the fiscal cliff, corporations already are starting to lay off workers. The independent Tax Policy Center estimates that taxes will increase almost $3,500 per household as a result of the fiscal cliff.

It remains to be seen whether the fiscal cliff will be resolved before the year is up, but even if that happens the U.S. could still have its rating lowered by Moody's due to the political stalemate and partisanship that has gone on the past two years.

Immediately after the election all focus has shifted towards the fiscal cliff and whether or not Congress and the president can work together.

House Speaker John Boehner, R-OH, has been very vocal after the election, calling for compromise and insisting that Republicans can accept more revenue.

However, many are wondering if that is just a post-election piecemeal offering and if his true feelings were voiced before the election.

"The threat to American jobs comes not from action on our debt, but from inaction on our debt," Boehner said in September. "The president and his economic advisers have consistently perpetuated the myth that downgrades are caused by efforts to force the government to stop spending money we don't have."

Despite the finger-pointing in Washington, Moody's Chief Economist Mark Zandi stated in his November outlook that he expects the fiscal cliff to be averted because of the gravity of the situation.

"Going over the fiscal cliff or breaking the debt ceiling would have a widespread impact on the economy, nearly all of it negative. Given the suffering that would occur if policymakers don't act, therefore, the most plausible outcome is that they will," Zandi said in the company's November outlook.

Should We Embrace the Fiscal Cliff?

Besides Moody's, many other economists, including the Congressional Budget Office, expect the U.S. to enter a recession in the first half of next year if no deal is reached.

If a deal can be reached, Moody's sees real GDP growth around 2% in 2013, which will nearly double in 2014 and stay near 4% in 2015. Also, it expects job growth to accelerate from approximately 2 million jobs per year today to a pace closer to 3 million and for unemployment to fall definitively as job creation picks up pace.

Yet, the CBO predicts going off the fiscal cliff will actually be good long-term, causing GDP to turn around in the second half of 2013, rising 2.3%. Then, in 2014, GDP jumps up 5%, followed by an astounding 6.4% increase in 2015.

What can be taken away from that is if Congress and President Obama can reach a deal that involves some form of higher taxes and reduced spending, the country most likely will slow down at the beginning of next year before gradually improving.

But, if the decision is to continue the status quo, with Democrats agreeing to extend the Bush tax cuts and Republicans putting off spending cuts, it will only delay the inevitable.

At some point the U.S. must deal with its debt crisis and this will require sacrifices to be made, the only question is will those challenges be faced now or later.

For more information to help prepare you for the fiscal cliff, check out this analysis by our Chief Investment Strategist Keith Fitz-Gerald on how there are actually three fiscal cliffs, not one.

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  1. brian | November 13, 2012

    I don't think there will be any agreement other than to postpone making one until next year. Obama will force higher taxes that Republicans don't want and the defense cuts are a big question mark

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