U.S. Fiscal Cliff, Other Economic Factors May Converge into Global Worst Case Scenario

The IHS has released its Worst Case Scenario economic outlook, which includes a potential plunge off the fiscal cliff, that, together with additional global factors, would send the U.S. economy into recession and cause the country’s gross domestic product (GDP) to contract for the first time since 2009.

 

The fiscal cliff is just one of several global events analysed in the IHS worst-case scenario outlook for 2013, which also incorporates degradation of the Eurozone, conflict escalation in the Middle East and a hard landing in China.

 

Triggering a global worst-case scenario
“The U.S. economy stands at the precipice, with tax cuts expiring and federal spending cuts triggered by the Budget Control Act of 2011 set to commence at the start of 2013,” says Nigel Gault, chief U.S. economist at IHS.

 

If the United States federal government fails to resolve the fiscal cliff and the other plausible events unfold -- including a surge in oil prices caused by escalating Mideast conflict, the rapid departure of six countries from the Eurozone and a significant slow-down of China’s economy -- such a worst-case scenario could see U.S. economic output drop during the first two quarters of the year and real GDP would subsequently contract by 1.7 percent in 2013 -- a sharp contrast from the baseline forecast. 

 

Other countries would fare much worse under this scenario, with some countries, including Italy and Spain, seeing more than a 4 percent decline in 2013.

 

The Cliff
In a plausible worst case scenario, the fall off the fiscal cliff and the onset of recession will demolish equity values and boost bond prices. The Federal Reserve will likely respond by adding more stimulus, however, this will be ineffective against the magnitude of the fiscal contraction.

 

Given the magnitude of this potential disaster, it’s hard to imagine the U.S. government will allow it to continue for very long.  At some point—likely three to six months into the year—the economic pain and political damage will become too acute. One or both parties will blink, and a settlement will result. In this scenario, IHS assumes that the Bush tax cuts will be partially restored.

 

Meanwhile, sequestered funds for defense spending may be reinstated by July 2013 as international tensions increase—perhaps related to new hostilities in the Middle East.

 

A solution by mid-2013 will be too late, serving only to mitigate damage, with the worldwide economy already heading into a severe recession.  The unraveling of these volatile, inter-dependent events make up the underlying assumptions central to a possible worse-case scenario that would be catastrophic to world markets.

U.S. not alone
There are plenty of implications for the United States, but these are worsened by the interconnected and interdependent nature of global markets – intricate dependencies contributing to a worse-case scenario. Catastrophes including a chaotic breakup of the

 

Eurozone and a hard landing in China play a significant role in any potential for marketplace calamity.

 

“While the U.S. fiscal cliff is in the spotlight and is certainly a major cause for concern, the turbulent exit of six countries from the Eurozone is a critical situation to monitor for its near-term implications on marketplace upheaval, while a China hard landing is a dominant factor threatening medium- and long-term results,” added Sara Johnson, senior global economics research director at IHS.

 

In the wake of such events, global corporations of all sizes will struggle to perform and could face a critical inflection point determining their future success or failure.

 

Each industry could witness shocking market exits, not unlike the collapse of Lehman Brothers in 2008, in which cutting production and reducing costs ran rampant as a reactionary survival strategy rippling throughout supply chains.

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