With earnings season coming to a close, and the Facebook IPO http://www.thefiscaltimes.com/Business-Economy/Trends-Outlook/Company-Sp... having delivered entirely the wrong kind of “pop,” U.S. financial markets now are increasingly likely to find their fate being shaped by two unpleasant scenarios: “taxmageddon” and “drachmageddon.”
A foretaste of things to come hit the market Tuesday, in the shape of two pieces of news that rocked investor confidence. First came news on the “taxmageddon” front: the Congressional Budget Office announced that the U.S. economy is likely to lapse into another recession early next year if automatic spending cuts go into effect as planned and if no action is taken to extend a package of tax cuts first implemented nine years ago. Effective tax rates for most Americans as well as for businesses are set to jump, as will the rate at which dividend income is taxed. Also looming on the horizon is an end to a payroll tax cut holiday and a whole host of spending cuts on which politicians appear unable to agree.
If Republicans and Democrats can’t agree on an alternative path forward, the CBO warned, then the economy will, lemming-like, run straight off the “fiscal cliff” and cause the economic recovery to grind to a halt. The agency predicts the economy will shrink by 1.3 percent in the first half of 2013 if everything is left untouched; if Congress manages to pull itself together and extend the tax breaks while eliminating spending cuts, the economy could create two million jobs in 2013, while growing at a rate of 4.4 percent.
It’s a stark dilemma – how to properly balance growth and fiscal health – and it is one that already is making investors extremely uneasy. The closer we come to the November elections, the more it is likely that those jitters will shape the direction of the stock market, regardless of who seems likely to win the White House or end up dominating Congress, since neither party seems prepared to give way on these issues, which already have come close to shutting down the federal government.
Not ominous enough? Well, there is the ticking time bomb now being referred to as “drachmageddon,” or the prospect that Greece will abandon – or be forced out of – the Eurozone in the near future. European politicians, including British Prime Minister David Cameron, have taken to the airwaves to huff and puff about the apparent wish of Greek voters to possess and simultaneously devour their cake. "They cannot just vote for saying, 'could people just carry on giving us some money so we do not have to change anything,'" Britain’s Justice Secretary Kenneth Clarke (a former chancellor of the exchequer) pointedly warned, cautioning the Greeks against the ramifications of electing “cranky extremists.”
The news on “drachmageddon” – or the possibility that the Greeks will wake up one morning this summer to find that the Euros in their bank accounts have been swapped back into drachma, their pre-Euro currency – wasn’t any better today. An EU summit is scheduled to take place in Brussels, but leaders aren’t speaking with a single voice in the discussions with Greece. German Chancellor Angela Merkel has signaled some willingness to compromise, but her views still remain poles apart from those of her newly elected French colleague, French President Francois Hollande.
While the CBO report spooked stock market investors yesterday, contributing to the fact that the trading session’s early rally sputtered and stalled, headlines that former Greek Prime Minister Lucas Papademos sees the risk of Greece leaving the Euro as “real” and that the country is pondering its options only made matters worse. “It can not be excluded that preparations are being made to contain the potential consequences of a Greek euro exit,” Papademos told Dow Jones Newswires.
A recession is bad enough – but we have been through those before and worked our way out of them again. A recession combined with having to cope with the fallout from a Greek exit from the Eurozone would cause chaos that would rapidly spill over into the rest of Europe and its major trading partners in North America and Asia.
There appear to be no contingency plans in place to either avoid or to cope with what might follow, and some ugly scenarios are possible. One involves the impact Greece’s exit might have on Spain, which rapidly would take Greece’s place as the weakest nation in the Eurozone and which is in the midst of its fourth attempt to contain a national banking crisis. Will Europe’s political leaders have the political will and the economic firepower to bail out entire nations the way that the U.S. bailed out its financial institutions? It is on questions of that scope and nature that the fate of all global financial markets – including the U.S. stock market – are likely to rest throughout the summer.