No economic image has captured the American attention this year as much as the picture of driving over a fiscal cliff into an economic suicide, a la Thelma and Louise. Even if President Obama and House Speaker John Boehner end up swerving at the last minute, the fiscal cliff still wins as this year’s top economic story.
Next on the list are four stories dealing in big numbers, specifically the 47 percent and the 1 percent, the $650 billion European bailout fund, Facebook’s botched $100 billion stock offering, banks paying $5 billion in fines for bad behavior, and China’s $8 billion interest in American businesses.
Here’s the list:
1. Fiscal cliff throws the economy a $500 billion punch — Politicians may yet save the economy from the $500 billion in tax increases and spending cuts that make up the fiscal cliff, although the failure of Speaker John A. Boehner’s Plan B doesn’t give much hope of that outcome. To some extent, the disagreement arises over who’s well off enough to pay higher taxes that will arrive with the expiration of the Bush-era tax cuts at the end of the year. Is it those who make more than $400,000 as Obama believes, or is it those who make more than a million a year as Boehner (R-Ohio) insists?
The classic Washington strategy of throwing out a policy and seeing what sticks is now running the fiscal show. These ideas include changing the way that Social Security benefits are adjusted for inflation, taking away the federal tax exemption for municipal bond interest, cutting reimbursements for 1 million doctors providing Medicare services, scaling back the charitable deduction, limiting the value of deductions that any individual taxpayer may claim, and so on.
Meanwhile, forecasts of calamity if the economy topples over the fiscal cliff are abundant. Low-income families might lose $1,000 in tax breaks, and millions of not-very-high-income individuals might have to pay a tax that was originally designed to hit only high-income individuals. Scheduled cuts to Medicare raises exceptional ire, with groups such as RobinHoodTax.org rallying around the cry “Don’t Push Senior Citizens Off the Fiscal Cliff. Tax Wall Street.”
Even the Pentagon is afraid that losing the roughly $50 billion in spending next year through the sequester would have “devastating effects on the Department of Defense,” and leave the military a “less-capable, less-modern, less-ready force and [risk] creating a hollow military,” as Pentagon Comptroller Robert Hale testified this fall before the House Armed Services Committee. If the combined tax increases and spending cuts take place, we’ll ring in the New Year with a recession. Ouch.
2. The 47 percent — When Presidential candidate Mitt Romney commented that 47 percent of Americans don’t care about his tax policy because they don’t pay taxes, he was reflecting the truth in one sense. Every year, about half of Americans don’t owe federal income tax for lots of good reasons — they don’t make enough money, they’re retired and receiving Social Security benefits, or their deductions, say for medical expenses, charitable contributions, or losses, drive their tax bill to zero or below. Unfortunately for Romney, though his comments may have reflected the facts, they didn’t reflect voter sentiment. He eventually lost the election to Obama when he received just 47 percent of the popular vote.
Romney was already in trouble for being part of the 1 percent — the share of Americans who are in the top 1 percent of the income distribution, made famous through last year’s Occupy Wall Street movement. Romney made his fortune at Bain Capital, a private equity spinoff from Bain and Co. that he led until retiring in 1999 to run the Salt Lake City Olympics. Bain Capital makes money by buying up, restructuring, and then selling off companies that are in distress. Staples, Inc., the office supply store, is one of Bain’s success stories; American Pad & Paper is not. Romney didn’t get into trouble so much for his work at Bain — his problems arose because he doesn’t pay a very high tax rate. As his tax return showed, he paid an average 14 percent tax rate in 2010 and 2011, a figure that drives his tax rate well below the rate of the typical secretary (Billionaire investor Warren Buffett believes that his tax rate shouldn’t be lower than his secretary’s tax rate. Buffet says his tax rate is 17.4 percent. We don’t know his secretary’s tax rate.).
3. European central bankers struggle to preserve the euro, while Bernanke saves the U.S. economy — Greece slogged through a fourth year of recession and faces an economy that will be 20 percent smaller next year than it was five years ago. In March, a group of Greece’s private creditors agreed to accept a 75 percent loss on their Greek debt, allowing Greece to reduce its debt load by $132 billion, but leading to a technical default. Greece elected Antonis Samaras prime minister in June, who soon had to deal with violent strikes over the austerity packages imposed as a condition of receiving a bailout. Unemployment rose to 24.8 percent. By September, companies began to plan for the possibility that Greece would leave the euro, although European leaders insisted that wouldn’t happen. Conditions improved enough in December when Greece received another $69 billion in bailout funds so that Standard & Poor’s raised Greece’s credit rating by six notches, bringing Greece out of default though leaving the country’s debt with a junk rating. To provide long-term relief, the Europeans provided its new European Stability Mechanism with what’s being called a $650 billion bazooka.
In the United States, Fed Chairman Ben Bernanke vowed in December that the Federal Reserve would follow a low-interest rate policy indefinitely. With the target federal funds rate near zero, the Fed will continue its “quantitative easing” and purchase $85 billion in Treasury bonds and mortgage-backed securities each month for the near future. In a change from past policy, Bernanke announced that the Fed will look to the unemployment rate for policy guidance and will keep rates low until the unemployment rate falls below 6.5 percent as long as inflation is no higher than 2.5 percent. The Fed doesn’t expect to implement this policy soon — it projects that the unemployment rate, which fell to 7.7 percent in November, will stay above 6 percent until at least 2015.
4. Facebook’s disastrous IPO and banks behaving badly — The joy investors felt over finally being able to buy shares of a company that they really like — Facebook — drove the company’s valuation above $100 billion that day. That was soon followed by disappointment as the share price fell from $38 to below $30 just six trading days later and to about $27 today. Accusations that Facebook’s investment bankers, Morgan Stanley, gave privileged investors gloomy forecasts that they didn’t give others didn’t help soothe those initial investors’ feelings. As for the information to privileged investors, on Dec. 17, Massachusetts authorities fined Morgan Stanley $5 million for violating securities laws when its bankers told its analysts that they didn’t think Facebook’s revenue would be as strong as forecast. Bankers aren’t supposed to do that. Facebook has not been accused of any wrongdoing.
On related financial notes, more than four years after the financial crisis erupted, banks continue to behave badly. UBS, Barclays, HSBC, and Standard Chartered together paid nearly $5 billion in fines this year connected to improper actions. UBS, Switzerland’s largest bank, paid $1.5 billion in fines after admitting that it committed fraud when it provided false information for purposes of calculating one of the world’s most important benchmark lending rates, the London Interbank Offered Rate, or Libor.
Six months earlier, British bank Barclays Plc. had agreed to pay $453 million in fines for manipulating this interest rates. After a Senate investigation led by Carl Levin (D-MI) found that HSBC had acted as a conduit for “drug kingpins and rogue nations,” that British bank agreed to pay $1.9 billion to settle charges of money laundering involving Iran. British-based Standard Chartered bank agreed to pay $300 million in fines for money laundering through some 60,000 transactions with Iranian clients worth $250 billion over the past decade. In the U.S., JPMorgan Chase lost $5.8 billion from trading losses by Bruno Iksil, familiarly known as the London Whale.
5. As China’s economy sputters, Chinese businesses look to America — In 2011, China’s $7.318 trillion economy became the second largest behind the United States, although at $4,940 per person, China ranks just 114th in the world per capita, according to the World Bank. In November, China made a once-a-decade leadership change when Xi Jinping, became president and general secretary of the Communist Party and Li Keqiang became premier.
China’s new leaders will preside over an economy forecast to grow 7 percent in 2013, its slowest growth rate in 23 years. Slow domestic growth has stimulated Chinese companies to look to the United States for investment projects. Rhodium Group estimates Chinese firms will invest a record $8 billion this year in American businesses, ranging from clean energy to fossil fuels to entertainment complexes.
In December, a Chinese firm bought the bankrupt battery-maker A123 Systems for about $250 million, while a group of Chinese firms feels confident enough about the AIG brand that it agreed to purchase AIG’s aviation-leasing business for just over $4 billion.
Given the sensitivity of Chinese investment in the U.S., these are not done deals. The U.S. committee that’s responsible for evaluating the national security implications when foreign entities wish to purchase a U.S. company has yet to rule on the A123 and AIG purchases, while some deals may never go through. In September, Obama blocked a Chinese-owned company from building wind farms in Oregon on the basis of national security.
Joann Weiner teaches economics at The George Washington University. She has previously written for Bloomberg, Politics Daily, Tax Analysts and worked as an economist at the Treasury Department. Follow her on Twitter: @DCEcon.