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A Spectator's Guide To The Fiscal Cliff Negotiations

Watching the legislative process in Washington can be as unappealing as watching sausages being made. But it helps if you know what to watch and what not to watch.

When it comes to legislation to avoid the fiscal cliff, there is certainly no shortage of people watching. Earlier this week, Ben Bernanke joined the chorus of economists urging the government to find a timely solution to the problem. This is consistent with comments Bernanke has made previously, which indicate that he knows all too well that whatever power the Fed has to affect the economy via monetary policy will be overwhelmed at this point by decisions about fiscal policy.

The key details

So far, the fiscal cliff standoff has been surprisingly short on new rhetoric, let alone action. Think of this as the opening moments of a boxing match, when the fighters circle each other looking for an opening. As you wait for developments to begin, here is a quick guide to watching the fiscal cliff negotiations:
  1. Don't read the rumors. The politicians involved are well aware that this is a spectator sport. They will make statements designed to influence public opinion, and leak information to make themselves look good. Just remember that until a deal is done, any public statements or rumors are just smoke and mirrors.
  2. Think of the financial markets as a hammer. The stock market has had some crazy days lately as it tries to anticipate the outcome of the fiscal cliff negotiations: down more than 300 points on November 7, down 185 points on November 14, then up more than 200 points on November 19. This kind of erratic behavior can be hard to watch -- especially the losses. It helps to remember that the financial markets act as a kind of hammer in these situations -- they pound home the message that there will be financial consequences to Washington's actions. This hammer is one of the few things politicians on both sides of the aisle pay attention to.
  3. Don't forget about the rest of the world. Important as the fiscal cliff is, there is an outbreak of hostilities in the Middle East, and continuing developments in the European financial crisis. In today's world, no event takes place in isolation.
  4. Realize that the deadline may not be such a deadline. January 1, 2013 is widely reported as the deadline for a solution, because that's when a package of tax increases and budget cuts would take effect if there is no further action. The truth is, that's not such a hard deadline. Tax breaks passed during the year can be made retroactive to the start of the year, and budget cuts phase in over an extended period of time. It turns out the fiscal cliff is more of a long downhill slope.

Through it all, just remember that it doesn't ultimately matter how ugly it is to watch the sausage being made. What matters is whether the end product is any good.

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