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Why did stock markets have a cow after Obama won? And what does this mean to your money?

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Glad you asked. It’s fairly simple, but first you have to know what the ‘fiscal cliff’ is. American politicians passed laws some months ago mandating federal spending cuts unless new laws are passed changing them (nothing is simple). Meanwhile a whack of tax cuts brought in by George Bush are scheduled to expire at the same time (New Year’s). Plus the US is bumping up against its debt ceiling, which means Washington must raise it or run out of cash.

All of this happens about the same time (in 60 days, more or less). That’s the cliff. It would bring substantially higher taxes and deep spending cuts – a $607-billion hit to the economy. Economists, and even that little beaver, F, believe this will cause a recession in 2013. Recessions bring job loss and crappy profit numbers. So, the markets sold off.

Why after election day? Didn’t we all know this was coming?

Of course, but in recent weeks Wall Street was factoring in the potential for a Romney win as his poll numbers climbed, or a shift in the balance of power in Washington. Didn’t happen. Now Democrats control the White House and the Senate, while Republicans control Congress. Worse, more of those pesky right-wing Tea Party zealots have been elected, who’d be happy if government ceased to exist.

In a word, gridlock. Maybe. But even the chance of a war between the Republicans, who want no tax hikes and spending cuts, and Obama, who wants higher taxes and more spending, is enough to make investors sell equities and go to cash. So, markets tumbled a little over 2% on Wednesday, while oil was smacked with a 4% drop.

What happens if the States dives over the cliff?

Then 2013 would be a tough year in which the deficit would be cut in half, but at the expense of economic growth and a few million jobs. Taxes would rise for individuals and small businesses while government spending would eat into social programs and defence. GDP would sink, and a recession ensue. A few months later, we’d feel it too. If you think condos in the GTA and houses in East Van are unloved now, just wait.

This reminds us of the last debt crisis, fourteen months ago. Republicans and Democrats had a cat fight over raising the debt ceiling, raising fears among the rabble that America would default. Meanwhile US debt was downgraded by S&P and the Dow routinely lost 400 points a day. The Occupy Wall Street people were getting their heads busted. And this pathetic blog was overrun by people telling us to sell everything, buy gold and store toilet paper. The good kind.

What happened? A compromise, of course. Like me, it was late and messy, but it did the job. There was never any reason to believe American politicians would suicide, and those people who bought when others bailed enjoyed a win. In the early days of October, 2011, the benchmark S&P 500 plunged to less than 1,100 amid the wailing and moaning. A year later it was above 1,400, for a gain of 34%.

History is about to repeat.

Fiscal cliff phobia will spread, becoming as commonplace and loathsome as Justin Bieber, Kias or an Aerosmith revival. The impressionable will overact, wait for markets to fall substantially and sell when the moment of maximum despair is reached. This is exactly what happened last October when, ironically, risk came off.

Eventually a political compromise will emerge and the odds of recession melt away. The solution will be imperfect, and set us up for the next mess. But it will also give the economy time to churn out more jobs, have markets rebound, see the US housing market stir (more good news there on Monday) and rescue the Christmas retail trade.

Problems still abound. It looks like Greece will be burning for a while and Germany’s catching fever. The next decade could well yield years of virtually no growth, structural unemployment, deleveraging and incomes not even pacing inflation. But there’ll be no collapse, no failed banks, no reason for cupboards full of Cottonelle, Starkist or Purina. People with balance, diversity and liquidity in their investments will be fine. People with only houses won’t.

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Since last October the average Toronto detached home gained 5%. In Vancouver it’s worth 12% less. That’s the cliff to worry about.

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avatarGarth Turner - The Greater Fool posted Wednesday, November 7th, 2012.

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