With the deadline to solve the latest potential economic crisis in the US rapidly approaching, you have probably heard of the fiscal cliff - but what is it? Here are some answers to some of the most frequently asked questions about the fiscal cliff.
What is the fiscal cliff?
The term fiscal cliff refers to a combination of dramatic spending cuts and tax increases mandated to come into effect in January. To avoid the cliff, US president Barack Obama has to strike an agreement with Republicans who control the US House of Representatives by the end of the year.
But why?
The Budget Control Act of 2011 codified in law a grudging political compromise forcing the government to slash spending by $US1.2 trillion over 10 years from January 1. Next year's cuts, called sequestration, would be about $US109 billion. Also on that date, a package of tax reductions and an extension of unemployment benefits will expire, meaning taxes will rise significantly for most Americans.
Why will this happen?
Democrats and Republicans have long been deadlocked over whether to address a $US1 trillion-plus annual budget gap with higher taxes or lower spending. The Budget Control Act was a poison-pill deal designed to force them to find a less austere compromise, but political wrangling and dysfunction meant no deal was done, and the deadline is now looming.
What happens if it is not avoided?
The Congressional Budget Office (CBO) says the higher taxes and lowered spending could slice the $US1.1 trillion deficit racked up in the 2012 fiscal year by almost $US500 billion next year. While this would vastly improve the government's financial picture, the CBO estimates the shock treatment would send the country back to recession and push the unemployment rate to 9.1 per cent. Deep cuts would come to both domestic programs and defence spending. Government suppliers and contractors would lose business, and temporary furloughs could be in store for tens of thousands of federal employees. Taxes and automatic pay check deductions would increase for most Americans - reducing the cash they have for spending - and taxes on capital gains and dividends would rise, hitting investors.
What is the debt ceiling?
The US government will hit its statutory $US16.39 trillion debt limit on Monday, according to treasury secretary Timothy Geithner. The limit is set by Congress and if it is not raised, the US will not be able to borrow any more money and would, in theory, be forced to slash spending to make ends meet. Possible, but desperate, remedies would include halting pay to the military, retirement health benefits, social security and failing to pay government debts.
Will the US default on its debt?
Not immediately. The treasury has various extraordinary measures in its armoury, including halting the issuance of securities to state and local governments, which could buy about two months of leeway.
What would a default mean?
No-one is sure: the dollar and US treasury bonds are the primary currency of global finance, and holders do not really have any alternatives. Most believe that eventually the US government would make good on its debts. However, the country's credit rating could be further downgraded, likely pushing up its borrowing costs over the medium-term and possibly diminishing the dollar's cachet in world finance.
What will Congress do?
Eventually, Congress is likely to raise the debt ceiling, but Republicans who run the House of Representatives will use the showdown as leverage to demand spending cuts from the president in return. It is uncertain how high the raised borrowing limit will be, and in any case, any resolution will likely trigger a new confrontation between Mr Obama and Republicans the next time around.
What dit I do?
I liquidated a large part of my share holdings in anticipation of a market fall.
What did the market do?
It went UP!
