For months, Americans have been hearing about the “fiscal cliff.”
Washington gridlock, we’re told, is driving the country toward that cliff—and plunging over it would mean catastrophe for the economy and the stock market.
Let’s step back and take a breath. First of all, what is the so-called fiscal cliff? It’s simply a yearend deadline for Democrats and Republicans to agree on a plan to reduce the country’s debt. The parties created the deadline this summer as a way around their debt-ceiling impasse.
If Washington can’t reach an agreement by January 1, major spending cuts and tax increases would be triggered. It’s true that would put the country on course for a recession and would impact the stock market.
But there’s a big caveat: The fallout wouldn’t be instant. It would be spread out over time—more like a hill than a cliff. Of course, the whole scenario will be avoided if our elected leaders reach a deal by year’s end. But what if they don’t?
Despite what the doomsayers tell us, the economy wouldn’t drop like a rock. We wouldn’t fall off a “cliff.” Instead, experts agree, we’d start rolling down a fiscal hill. And at any point on that trip down that hill, legislators still could—and presumably would—make a retroactive deal that would stop the descent.
Does anyone know exactly how debt negotiations will play out? Of course not. But since the presidential election, there has been at least a modest shift in the political rhetoric, with a little less saber rattling and a little more talk of compromise. That’s promising.
A deal, however imperfect, seems probable. As Wall Street Journal columnist David Weidner recently wrote, “The most likely outcome is a combination of tax increases, spending cuts and kicking the can down the road.” The looming deadline for an agreement, as Weidner notes, is pure political “theater.”
So what should we as investors take away from this drama? Mostly, it should remind us about the tendency of politicians and the news media to create unwarranted hype. Both of these groups keep referring to a “cliff,” even though most of their members know that the analogy is wrong.
Politicians in both parties are probably using the term to scare their counterparts into making concessions. As for our news media, framing stories in sensational terms—in order to attract as many readers as possible—is as old as the profession itself.
As always, the wisest course for investors is to make a long-term plan and stick with it. Plenty of investors jump in and out of the market based on news headlines, and the results are rarely good. In fact, periods of hype and high emotion, like the one we’re going through now, are when self-discipline can really pay off.
But there’s one smart short-term action that you should take: Tune out the “fiscal cliff” hype as best you can, starting right now. Sure, you’ll be sacrificing some drama, but you’ll very likely make up for it in peace of mind.