The Fiscal Cliff

Monday, 22 October 2012
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Published in From The CEO

In the first two days of next year, we will see large tax cuts expire which were passed in 2001 and 2003.  As a result, the nation will undergo cuts to both defense and nondefense programs.  Taxpayers will notice a cut in pay during the first two weeks in January.  The lowest income tax rate is slated to rise from 10 percent to 15 percent. And the highest tax rate is slated to rise from 35 percent to 39.6 percent.  Tax rates on dividend rates now at 15 percent are slated to rise to 39.6 percent.

The majority of defense programs will be cut by 9.4 percent. Most nondefense programs, except for Social Security Medicare and Medicaid will be cut by 8.2 percent; and Medicare will be cut by 2 percent.  Social Security, veterans benefits, military personnel, Medicaid and the Children’s Health Insurance Program will be spared cuts.


No doubt about it:  this major reduction in the federal budget will apply the brakes to the U.S. economy.  Economists in the public and private sectors agree that these cuts are a natural invitation to recession.  Nobody is more aware of the consequences of the budget reduction than Federal Reserve Chairman, Ben Bernanke.  In fact, it was he who coined the term “fiscal cliff.”

Reuters reported back on October 5th that investors could be looking at gold as their “top commodities choice” for a difficult fourth quarter in anticipation that the fiscal cliff will prompt printing of more money.  Although gold has retreated in price since the news agency made this observation, it’s certainly possible that investors will grab at lower prices as we approach the year’s end.  Keep in mind we noted in a previous column that HSBC precious metals analyst Jim Steel, even in view of gold’s pullback, issued an upward revision of the yellow metal’s price for the coming year.

The reasoning behind this possibility seems clear.  Since Ben Bernanke has pledged to pump money to keep the economy afloat, the consequences of the fiscal cliff would in effect force the Fed to keep its word with respect to QE3. The printing of more money is likely to prove an additional steroid for gold.  Under the circumstances, Paul Morilla-Giner, chief investment officer at London & Capital, views gold as “flirting with $1,900 or $1,950.

Regardless of your metaphor of choice in trying to understand the market – the “slingshot effect,” the “boomerang effect” – the pullback in gold is due for its next ride up.  You should not try to chase the market or look for a bottom.  Nor should you try to wait for the election to start accumulating gold.  The results of the fiscal cliff will dog the President as well as the presidential hopeful.  While Obama is looking for legislation that extends cuts for families earning $250,000 or less, he still has to deal with a Congress that has been largely unsympathetic to this extension.  And despite Romney’s pledge that he will not allow automatic tax cuts to happen, he wouldn’t take office until January 20th of 2013. And it’s unclear what he’ll do to honor his pledge.  During the current fiscal mess, gold is your best portfolio insurance.

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Trevor Gerszt

Trevor Gerszt has been passionate about gold since childhood. Growing up in South Africa, the world’s second largest gold producer, Gerszt spent his youth collecting gold coins. Surrounded by a family of experienced coin collectors, he gained valuable insight about the precious metal.