The Rainbow after the Storm

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Friday, 2 November 2012, 7.55 am, and Saturday, 3 November 8.35 am)

The US Fed has been moderately successful in getting Americans to spend and boost the economy. But as the year comes to a close, Americans are zipping up their wallets.

This is because they fear the approaching fiscal cliff. This is when around US$600 billion of US government spending cuts and tax hikes will kick in from January 2013.

This fiscal cliff is bad news. As a proportion of GDP, the US spending cuts are comparable to the cuts troubled European countries like Greece and Portugal have been forced to undertake.

How did this fiscal cliff come about? It’s a fluke really. Like the perfect conditions that created Superstorm Sandy last week, two factors led to the creation of this fiscal cliff.

The first factor is the end of numerous tax holidays next January which the Bush administration generously gave out a few years ago.

The second factor is the agreement made in August 2011 to reduce the US budget deficit by way of spending cuts starting in January. This agreement was made in Congress as a condition for raising the US debt ceiling, or the legal amount the US government is allowed to borrow.

Just as Americans living along the east coast had braced themselves for Superstorm Sandy, global investors have been bracing themselves for this approaching economic disaster.

Unlike hurricanes which cannot be avoided, this fiscal cliff can be avoided if US lawmakers, from both the Democratic and Republican sides, come together after the US Presidential elections to thrash out the issue.

But these lawmakers are known to drag and bicker. So there is little confidence that any sort of agreement could be reached before January.

This pessimism is one of the main reasons why major stock indices have been trending down as investors brace themselves for another US recession.

But all is not lost. The US economy may yet be saved by Superstorm Sandy which devastated the east coast of the United States. This wealthy region of the country accounts for 20% of the total population and 25% of total GDP.

The bad news is the damage caused has been estimated at between US$20 to US$50 billion. The good news is that in many cases of natural disasters, the rebuilding effect on the economy exceeds the disruptive effect.

For instance, after the Japanese earthquake in March 2011, the economy picked up strongly two quarters later.

Of course, every case is different. After Hurricane Katrina hit New Orleans in 2005, the rebuilding effect was weak. But this is mainly because New Orleans is a poor region and US lawmakers did not feel any urgency to act.

This is not the case with Superstorm Sandy. This time the wealthy region of the country has been devastated and lawmakers, who live mainly in the region, will be under intense pressure to act quickly.

These lawmakers will also be pressured to do something about the fiscal cliff and the US debt ceiling. So it looks like there is a good chance a US recession can be avoided.

If this rainbow after the storm appears before us, as I expect it to, it would be bullish for global stock markets. Then the S&P500 should rise towards the 1,500 level, and the Straits Times Index should rise towards the 3,300 level.