Nasty Election Could Wreck The Economy, BofA Economist Warns

08/24/2012 03:16 pm ET | Updated Aug 24, 2012
  • Mark Gongloff Managing Editor, Business and Tech, The Huffington Post

Like most Americans, you're probably thoroughly enjoying the nasty 2012 presidential election. We just can't get enough of the rape gaffes and the birth-certificate jokes, am I right?

But did you know that what you might consider frivolous electo-tainment could actually cause the entire U.S. economy to crash?

That is the warning in a new note by Bank of America economist Ethan Harris. He cautions that the ugly back-and-forth of this campaign could hurt the chances of Congress getting anything done about the "fiscal cliff," the $600 billion to $700 billion in tax increases and spending cuts set to take effect at the end of the year.

The Congressional Budget Office warned earlier this week that the cliff could cause a fairly deep recession in 2013, and Harris wrote in his note Friday that the election could make that nightmare scenario a reality:

Unfortunately, in our view, the “energize the base” campaign from both sides increases the risk of a poor outcome for the fiscal cliff. Recall that avoiding the cliff -- that is, $500 bn in tax increases and $200 bn in spending cuts -- requires that both parties do a 180-degree turn. They must quickly forget the campaign, turn their guns into plowshares and negotiate a compromise with the “enemy.”

Harris worries about two possible scenarios unfolding if the parties can't come to an agreement. In the first, both Democrats and Republicans use the cliff as leverage to get what they want, ending in a Tarantino-style standoff that leaves everybody dead: The Democrats let tax cuts expire so they can revoke the Bush tax cuts for the upper class. The Republicans let the spending cuts tax take effect so they can cut spending for everything except defense.

"The question then becomes how long does it take for one side to 'blink' and how much damage does it do to the economy and markets," Harris writes.

In the second scenario, if a new president and Congress are elected in November, then the new government might just let the tax increases and spending cuts happen and avoid cutting a deal with the old government, thinking it will get what it wants anyway after the inauguration in January. The trouble with this approach is that the new minority government in January could still make problems for the new majority, with filibusters and such. Again, the economy will burn while Congress fiddles.

Mitt Romney's selection of Rep. Paul Ryan (R-Wis.) also presents a problem for solving the fiscal cliff, Harris writes:

As a leading House conservative, Ryan has been pushing for immediate, front-loaded, action to reduce the deficit. Since arguably winning the debt ceiling battle last summer, House conservatives have been presenting budgets that include even bigger cuts than agreed to under the debt ceiling agreement and they have warned that they will use the next debt ceiling -- which likely hits in December -- as a negotiating lever. In our view, this group will block attempts to delay spending cuts for more than a couple months.

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