U.S. fiscal cliff: Is the world's biggest economy about to crash into recession - and drag the rest of us with it?
The U.S. presidential election might be too close to call, but one thing is certain. The country will face a financial crisis immediately after the victor is declared, whether it's President Barack Obama or challenger Mitt Romney.
Fresh from the polling battleground, bitterly divided politicians must return to Washington and strike a deal to tackle their huge deficit. A range of tax breaks will end and massive spending cuts kick in automatically on January 1 2013.
This deadline is what is ominously known as the 'fiscal cliff' - and many believe it's the biggest threat right now to the global economic recovery.
Fiscal cliff: Will warring U.S. politicians let economy fall over the edge?
The combined impact of the tax increases and government cutbacks amounts to around $660billion, or 4.3 per cent of U.S. gross domestic product. It is an immense amount to drain out of an economy at once.
Should U.S. politicians fail to reach a deal to amend or defer some of the measures, the U.S. government's own forecasters believe it will wipe around 2.1 per cent off the country's economic growth.
If the U.S. does jump over the cliff, the consensus is that it will tumble back into recession. And since its giant economy represents more than 20 per cent of global GDP, it would drag the rest of the world down with it.
The prospect is already making financial experts nervous, because the political fireworks likely to accompany any deal-making are set to create uncertainty and high volatility on world markets.
A related and potentially even more serious problem is also looming: the U.S. debt 'ceiling' - an agreed level of borrowing that the government is not allowed to breach.
The U.S. debt level is likely to start bumping up against the current ceiling of $16.4trillion by around December. That means politicians will have to vote to raise the ceiling, probably by February at the latest, or spark a catastrophic default.
The trouble is that the last time the U.S. got close to the debt ceiling and had to raise it in summer 2011, there was the most almighty political bust-up. The Democratic and Republican parties fought over it for weeks, even though a debt default by the biggest economy in the world risks a meltdown of the entire financial system.
In the end they did dodge disaster and raise the debt ceiling, but still put off getting to grips with the debt itself.
The desperate, eleventh-hour deal they struck back then is one of the reasons the U.S. is teetering on the fiscal cliff now.
Why is U.S. on brink of 'fiscal cliff'?
The 'fiscal cliff' came about because Democrats and Republicans are so divided over how to tackle the huge U.S. deficit that every single issue involving state spending ends in a stalemate, and real decisions keep getting postponed.
Broadly, Republicans are against tax hikes and favour slashing government programmes, with the exception of the defence budget.
Democrats are pushing for tax increases - at least for the wealthy - in exchange for long-term cuts to social welfare programmes, and are more willing to reduce defence spending.
To settle the debt ceiling row in summer 2011, a 'super committee' of 12 Republicans and Democrats were tasked with finding $1.2trillion (£769billion) worth of budget cuts.
Failure would trigger some $1.2trillion of 'automatic' cuts aimed at defence and social programmes cherished by one or both parties.
These were specially designed to be so unpopular they would force the super committee to come up with a better plan. However, the committee failed to reach agreement after months of wrangling - it conceded defeat last November.
Capitol Hill: U.S. is facing 'fiscal cliff' because Democrats and Republicans are so divided over how to tackle the country's huge deficit
At the time, Democrat President Obama blamed the Republicans for being unreasonable. He pledged to veto any Republican attempt to get out of the 'automatic' budget cuts.
Now these cuts, tailor-made to be unacceptable to one party and its supporters if not the other, are due to be imposed on 1 January 2013.
And they will coincide with a number of other big changes: tax cuts introduced by ex-president George Bush will expire, a payroll tax holiday will end, various measures related to Obama's healthcare legislation will kick in, and federal unemployment benefits will be axed, among other things.
By timing all this at once, the warring U.S. parties have in effect scheduled their biggest deficit showdown yet for the end of this year.
To complicate matters further, the deadline of January 1 means the fiscal cliff will have to be dealt with by current members of the U.S Congress - some of whom will have just lost their seats in the upcoming election - in the so-called 'lame duck' session before the inauguration of the next president in mid-January.
They might finally cut a deal, postpone hard decisions yet again, or let the U.S. economy fall over the cliff and into recession.
No one is sure of the outcome but financial commentators anticipate political deadlock, pantomime and chicanery in the months ahead. We round up their views below.
What does the City say?
Mike Ingram, market commentator at inter-dealer broker BGC Partners, predicts U.S. politicians won't come to a deal on the deficit until the last minute.
'The U.S. won't fall off the cliff. It will be a rather more controlled descent,' he says. '$660billion is a gargantuan sum even for the U.S. economy and it would tip it back into recession.
'There is a debate on how much fear of the fiscal cliff has already affected the U.S. Expectation of the fiscal cliff has already cut into GDP numbers and weakened job creation in the U.S.'
Ingram says efforts to reach a compromise on the deficit have been made more difficult by where the U.S. is in the electoral cycle, with the presidential and many Congressional races due in early November.
'The Republicans think they are in with a chance of the presidency. They are likely to hold the House, and have a decent chance of winning the Senate because 23 of the 33 seats being contested are Democrat held. They are thinking why compromise now? That means it will go down to the wire.'
He points out that the 'fiscal cliff' changes due on 1 January are a mixed bag that will impact the economy in different ways. For instance, the George Bush tax cuts that are due to expire will affect the well-off most, while cuts to government programmes - like Medicaid, Medicare and unemployment benefit - will hit the least wealthy.
'Even if the Democrats and Republicans get their heads together and go for $300billion of cuts, which $300billion?' he asks. 'Republicans want to keep tax cuts and hammer the unemployed even though economically that makes no sense, never mind ethically.
'They have been arguing over this forever. They came perilously close to a shutdown last year. Even if there is agreement, you could see one or other of the ratings agencies downgrade the U.S.'
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Standard & Poor's already cut the U.S.'s AAA rating after the row over the debt ceiling last summer, and Moody's might decide to follow suit, according to Ingram.
'One of the reasons S&P cited for the downgrade was political dysfunction,' he adds.
Ingram believes we will all be watching a 'political pantomime' play out in the next few months.
Keith Wade, chief economist at global asset manager Schroders, says: 'Avoiding the full fiscal cliff of 4 per cent, which would almost certainly be enough to drive the U.S. economy back into recession, will require both compromise and haste from politicians.
'With no discussions occurring pre-election (6 November), the re-convening of the "lame-duck" Congress on 13 November will be the first opportunity to thrash out a deal, just six weeks before the cliff is due to hit.
'The situation is further complicated by the disruption caused by the holiday season, with both Thanksgiving (22 November) and Christmas falling in this window.
'Finally, with the current Congress one of the least productive in history due to the ideological chasm separating the two parties, the omens for compromise and bipartisanship are poor.
'We expect that the uncertainty surrounding the size, and composition, of U.S. fiscal consolidation could dampen the appetite for risk assets, particularly equities, as we head towards the end of 2012.
'With little sign of a resolution, it would come as quite a surprise if businesses were not delaying investment and hiring decisions, and households their discretionary spending decisions, until the resultant impact on tax codes and order books are known.
'Furthermore, any changes to the relative balance of income and capital gains taxes could have profound implications for portfolio construction and investment philosophies.
'Finally, if we see political chicanery reminiscent of the August 2011 debt-ceiling debacle, both ratings agencies and investors will question the ability of U.S. politicians to make difficult choices, with negative implications for both the equity and bond markets.'
Andrew Morris of Signature, the portfolio management arm of wealth manager Rowan Dartington, says: 'The main political parties are united in their belief that something needs to be done, but as yet that is the extent of their unity.
'Perhaps predictably the Republicans are steadfast in their view that taxes should not increase, and the Democrats certain in their conviction that cutting entitlements [government spending programmes] is the wrong course of action. Thus the issue will not be dealt with seriously until after the Presidential election in November.
Investor nerves: Political fireworks likely to accompany any deficit dealmaking are set to create uncertainty and high volatility on world markets
'There will then be the "lame duck" session between November and the year-end, which is the period prior to the inauguration of the new president. A further complication is that at some point, probably in the first quarter of next year, U.S. politicians will need to revisit the debt ceiling as it once again approaches the threshold.
'There are very significant incentives for the two parties to reach a consensus. However, in the meantime any uncertainty is extremely unhelpful. Investors will remember the pain suffered last summer when this last came to a head.
'For the corporate sector, it makes forward planning very challenging and thus there is the danger that CEOs become more cautious, potentially taking on less new employees or taking a more restrained stance in terms of capex [capital expenditure] and expansion plans.
'In turn for the consumer, the timing couldn’t be worse given the importance of the festive period, and again the effect on confidence could see consumer spending come under pressure.
'With the raising of the debt ceiling last summer, we need to be mindful of the potential volatility, hopeful that an agreement will be reached but also appreciate the likelihood that it may once again be last minute.
'While potentially this could be another "can kicking" exercise, we also need to bear in mind how resilient the U.S. economy has proved itself - current economic data continues to paint a reasonably positive picture.'