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A Second Downgrade?

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Without a resolution of the vexing fiscal cliff, the U.S. could face spending cuts and automatic tax hikes amounting to $600 billion, which would automatically go into effect from January 1, 2013. This could in turn push up the national unemployment rate above 9% and shrink the Gross Domestic Product (GDP) by an estimated 4%. The Administration has about a month and a half to reach a bi-partisan deal. In the meantime, the rating agencies are watching every move in Washington, D.C.

One negative outcome of all this uncertainty is that U.S. companies, despite rock-bottom interest rates, have hoarded about $1.7 trillion in cash. Firms are curbing investments as they fret about the fiscal cliff at home, an economic slow down and change of guard in China, political turmoil in the Middle East and the Euro mess. The curtailment of business investment has serious ramifications for capital formation and productivity.

It’s not just industry that is worried about the cliff. Judging from the performance of the U.S. markets lately, investors may be spooked by a possible increase in taxes on dividend and capital gains.  

The President recently maintained his line that taxes must go up for the wealthiest 2% of Americans. In doing so, he has indicated that he will not buy into any deal that maintains the Bush era tax cuts for the rich. At the same time, President Obama added that the nation was not prepared for a tax hike on most Americans. In fact, he called on Republicans in the House to favor an extension of existing tax rates for families with an income of $250,000 or less.

Furthermore, the President added that he would be open to later considering reform of entitlement programs, including Medicare. For its part, the GOP leadership has indicated that they are open to tax reform and closure of tax loopholes, but oppose the imposition of higher taxes on the rich.  

Credit rating agencies must contend with so much uncertainty. Furthermore, the U.S. lacks the kind of strategic roadmap that rating agencies may be fond of seeing. Standard & Poor’s Rating Services, a part of The McGraw-Hill Companies, Inc. currently retains a AA+ local and foreign currency rating. Moody's Corp. (MCO - Free Report) has a negative outlook on the U.S. at present. 

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