If the U.S. dives off the fiscal cliff at the end of the month, as seems more likely by the moment, the markets and economic impact will depend on the depth of the plunge and the quality of the landing.
If a deal is struck sometime in January to reinstate at least some of the Bush tax cuts and a patch is applied to ensure the alternative minimum tax does not slam the middle class, the damage should be limited, many economists say.
Reinstating the payroll tax cut and extending unemployment benefits, both set to expire at year's end, would further ease any immediate hit to consumer spending and economic growth.
However, if no agreement can be reached early in the 113th Congress and tax rates stay elevated and the automatic spending cuts begin to bite, the damage could be much more severe, including a return to recession and a spike in joblessness back above 9 percent, according to the nonpartisan Congressional Budget Office and many Wall Street economic forecasts.
"I think the market will be upset if we go over the cliff, but it won't crater," said Jack Ablin, chief investment officer at BMO Private Bank in Chicago. "Ultimately, this will get patched up in the first few weeks of the year. One risk we do run is another [credit rating agency] downgrade."
The ratings agency downgrades could come not because the federal deficit and debt are spiraling out of control -- going over the cliff would significantly reduce the deficit -- but because Washington would once again have demonstrated an inability to work across party lines to come up with long-term fiscal plans that cut long-term debt without inflicting short-term economic damage.
Thus far, markets have sagged but not collapsed as the cliff dance plays out in Washington.
The Dow initially dropped more than 100 points Thursday afternoon after Senate Majority Leader Harry Reid said it was increasingly unlikely that a deal would be reached by Dec. 31, but later recovered to close down 18 points for the day.
Markets could get increasingly choppy before the final hour approaches next week, market strategists say. But so far, there has been nothing like the one-day, 778-point drop suffered by the Dow in September 2008 as the House initially voted down the Wall Street bailout known as the Troubled Asset Relief Program.
Some analysts suggest such a drop might be the only thing to force a deal in Washington.
Economists say the mostly placid markets reflect the fact that investors expect a deal in January and the economy and financial system are far from the kind of mortal peril they faced four years ago in the worst part of the financial crisis.
"Going a few days into January without a deal won't make much difference. It will just rattle the uncertainty cage," said David Kotok, chief investment officer at Cumberland Advisors. "But go a few months, and it's a much bigger problem."
For markets and investors, what happens with the fiscal cliff is a prelude to a greater concern: What Congress will do about the debt ceiling.
The Treasury Department says the U.S. will hit the debt ceiling on Dec. 31, but it can use extraordinary measures to ensure the U.S. does not default right away.
But such measures would be good for only a month or two, perhaps slightly longer if the U.S. goes over the fiscal cliff, which would cut spending and increase tax receipts.
If a fiscal cliff deal -- now or early next year -- does not include an increase in the $16.394 trillion debt limit, there will be another game of brinkmanship that could be more damaging.
The White House has said it will not negotiate around the debt ceiling next year. But Republicans are likely to demand significant spending cuts in exchange for any further increase in the borrowing limit. And unlike with the fiscal cliff, the debt ceiling deadline will be a hard one and going past it could lead to a market collapse, a spike in interest rates and a true financial crisis.
"Going over the fiscal cliff is nothing compared to the debt ceiling," said Nigel Gault, chief U.S. economist at IHS Global Insight. "Failing to raise the debt ceiling in time would be absolutely disastrous."
The economy's relative strength in the face of the cliff -- gross domestic product grew 3.1 percent in the third quarter -- also underscores what the nation stands to lose if Congress and President Barack Obama do not execute a last-second save and no deal is made in early January.
An economy finally showing signs of life after an extremely anemic recovery could be driven backward once again.
Signals of incipient strength are easy to find. In addition to the relatively strong third-quarter GDP reading, home prices and sales have finally begun to climb again, a factor that tends to make people feel wealthier and drives spending on home-related goods.
The Commerce Department reported Thursday that new homes sales rose 4.4 percent in November from October -- the fastest pace since April of 2010. In addition, initial claims for unemployment benefits dropped last week to the lowest level in more than four years.
But there also are signs that the fiscal cliff is already having a negative economic impact.
Business and consumer confidence, which had been on the rise earlier in the year on hopes for a stronger economic recovery, are once again on the decline. The Conference Board's measure of consumer confidence dropped to 65.1 on Thursday, from 71.5 in November, a bigger decline than analysts expected.
Consumer spending accounts for two-thirds of economic activity, so the psychological impact of going over the cliff -- nevermind the actual amount of money removed from people's paychecks -- is not insignificant.
The CBO reported in November that if all elements of the fiscal cliff were to go into effect, economic growth would stall out next year, with the biggest hit coming from the across-the-board increases in tax rates.
According to CBO's projections, "If all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product will drop by 0.5 percent in 2013 ... reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year." That contraction of the economy would "cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013."
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