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How Washington's Inaction Could Put Us in an Economic Death Spiral

10/07/2012 02:57 pm ET | Updated Dec 07, 2012

In all the fuss about the presidential elections, we seem to have all but forgotten about the bigger problem confronting America right now, and that is the upcoming 'fiscal cliff,' an unholy basket of tax hikes and spending cuts scheduled to hit in January if not averted by Congress (a level of fiscal tightening not seen since 1969 and the Vietnam War), and its inevitable sequel: the 'death spiral.'

Sure, since the Congressional Budget Office reported in August that the U.S. would likely go into a recession in 2013 as a result of the fiscal cliff, many economists have echoed this gloomy prognosis with varying degrees of alarm, but given the magnitude of the problem, it deserves a heck of a lot more analysis and attention. Regardless of who is in the White House next year, the solution requires the cooperation of both political parties, neither of which seems willing to bend, so I think it's time to sound the alarm.

Most of the discussion about the fiscal cliff only captures the medium-term consequences; beyond the potential 9% unemployment and 2.9% contraction in gross domestic product that it could usher in, there is a longer-term and more pernicious effect to be worried about, and that is the permanent damage that the US economy will suffer as a result of a prolonged recession.

It is obvious that steep budget cuts will directly impact employment (277,000 federal workers, 14% of the federal work force, could lose their jobs next year as a result) and hurt consumer spending as people lose their livelihood, but more importantly, if going over the fiscal cliff extends the recession by another two years, as the CBO fears it will, the U.S. will suffer a significant loss in productivity, a sharp decline in business morale, an erosion of its competitive edge, and a flight of investment capital out of the country. In today's credit-fueled business environment, lost productivity, declining market share, and capital deficiency can push companies quickly into bankruptcy or at least stall their growth even as global competition overtakes them.

The long-term damage to our economy by these elements, combined with tax increases that further erode individual and business liquidity (average tax increase of $3,500 per household according to the Tax Policy Center), will not just be severe but self-reinforcing, which could throw the U.S. into an economic death spiral.

Like a chain of dominoes, from manufacturing firms no longer able to compete in the global marketplace, services companies unable to hire more employees to service their clients due to a lack of capital, consumer products firms with no one to sell to, to banks staggering from delinquent loans and small businesses retrenching just to survive, the American dream will collapse over the next decade, and as that happens competitors such as China and India will take a growing share of the market and leave the U.S. so far behind that it will become almost impossible for us to recover.

Yet, despite all this, our politicians are unable to find partisan compromise on the fiscal cliff, although funnily enough, this issue represents something both Democrats and Republicans hate (spending cuts for the former and tax hikes for the latter), so it would seem that reaching agreement should be fairly easy. The fact that the two parties have been unable to do so points to the sheer dysfunction of our political system, and a clear indication that policy debates are no longer about results for the nation but about opportunism and posturing. This must change if the U.S. is to have any hope of real economic recovery, not to mention avoid the looming disaster directly ahead.

The alternative is an America that will become increasingly less relevant on the world stage, and eventually go from being a superpower to becoming a has-been. We can't allow this to happen.

Sanjay Sanghoee has worked at leading investment banks Lazard Freres and Dresdner Kleinwort Wasserstein as well as at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of two financial thrillers, including
Merger which the Chicago Tribune called "Timely, Gripping, and Original." Please visit www.sanghoee.com for more information.