Cliff may be a fear, but debt ceiling much scarier
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Investors fearing a stock market plunge — if the United States tumbles off the "fiscal cliff" next week — may want to relax.
But they should be scared if a few weeks later, Washington fails to reach a deal to increase the nation's debt ceiling because that raises the threat of a default, another credit downgrade and a panic in the financial markets.
Market strategists say that while falling off the cliff for any lengthy period — which would lead to automatic tax hikes and stiff cuts in government spending — would badly hurt both consumer and business confidence, it would take some time for the US economy to slide into recession. In the meantime, there would be plenty of chances for lawmakers to make amends by reversing some of the effects.
That has been reflected in a US stock market that has still not shown signs of melting down. Instead, it has drifted lower and become more volatile.
In some ways, that has let Washington off the hook. In the past, a plunge in stock prices forced the hand of Congress, such as in the middle of the financial crisis in 2008.
"If this thing continues for a bit longer and the result is you get a US debt downgrade ... the risk is not that you lose two-and-a-half percent, the risk is that you lose ten and a half," said Jonathan Golub, chief US equity strategist at UBS Equity Research.
US Treasury Secretary Tim Geithner said this week that the United States will technically reach its debt limit at the end of the year.
The White House has said it will not negotiate the debt ceiling as in 2011, when the fight over what was once a procedural matter preceded the first-ever downgrade of the US credit rating. But it may be forced into such a battle again. A repeat of that war is most worrisome for markets.