Goldman Sachs Exec Goes to Washington and Leaves Dismayed

Jim O'Neill, Goldman Sach's Chairman of Asset Management, just spent a week in Washington D.C.

He assumed that the horrific nature of the looming fiscal cliff crisis would light some fires under politicians and get them moving towards a resolution.

Boy was he wrong. As he puts it in his latest article:

“After the discussions I had with people in DC. although this was not a major feature of any discussions, I did leave more concerned than I had been this time a week ago about the ‘fiscal cliff’. I’d been assuming for weeks that in order to avoid the 4% of GDP tightening that no deal would imply, it would be easy to find a deal...

“One has to hope that the economy will be sufficiently robust, despite the fiscal issues, for the Fed to shift its position. A combination of large fiscal tightening and pressure on the Fed to reduce its monetary friendliness doesn’t seem like a great combination for equity markets. Of course, the lack of fiscal tightening and no agreement for future fiscal tightening doesn’t seem like a brilliant recipe either. I hope it’s just my jet lag but I find myself pondering the following: usually countries will not deal with tough fiscal challenges unless markets force them.”

Unfortunately, if and when the market forces action, it may be far worse than the 4% hit to GDP that is expected.

Many economists expect the hit to GDP to be a dollar-for-dollar ratio. Unfortunately, post-recession analysis doesn't support their historical data.

Research from the International Monetary Fund suggests a dollar of deficit reduction could drain as much as $1.70 from the economy, making the prospective belt tightening much more dangerous.

The IMF research suggests that every dollar of recent fiscal consolidation has drained anywhere from $0.90 to $1.70 from affected national economies.

That would put the drain on GDP from $540 billion, or just under 4% GDP, to about $1 TRILLION, or just over 7% of GDP.

With interest rates already as close to 0% as possible, there is little chance that the USA will have any chance of falling at the lower end of the scale.

We're out of ways to ease the burden of contraction without immediate congressional action.

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