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Fix fiscal cliff now or face next Great Depression

President Obama and Republicans are engaging in dangerous brinksmanship. Putting off a political solution to the looming “fiscal cliff” until after the election risks a second Great Depression.

Without a compromise by January, $400 billion in mandatory spending cuts and more than $100 billion in tax increases will immediately go into effect. With our economy only growing by only  $300 billion annually, such a shock would thrust it into a prolonged contraction.

The failure the Obama $767 billion stimulus package to adequately jump start growth makes a second such initiative unlikely. Interest rates are at already at record lows. These leave policymakers too few tools once things start unraveling. However, President Obama has given Republicans hardly any political choices but to roll the dice.

Facing reelection, he promises to veto any extension of Bush-era tax cuts for middle- income Americans if Congress does not raise rates on upper-income families. He won’t entertain meaningful cuts in entitlement spending or health care.

Today, in August, businesses are already curtailing investments in machinery and information technology, as a hedge against a contracting economy in 2013, and consumers are spending less. Retail sales fell each of the last three months.

But, even if Mr. Obama wins reelection in November, he likely will be saddled with a Republican House.

Armed with a mandate, he will get higher taxes on upper income families. However, he has made commitments to expand the US naval resources in the Persian Gulf and Asia to counter Iran and China. He can’t finance those without giving Republicans some of the entitlement reforms they want but can’t get now.

For the economy, one of three outcomes is likely:

1. President Obama wins in November but doesn’t reach a deal with Republicans before February or March. Mass layoffs begin late this fall, especially in the defense sector, and the economy stumbles badly.

2. Mr. Obama wins and deals with Republicans in Congress by late December. Taxes go up, and overall spending is cut, but not as much as current legislation requires. The combination still derails the fragile recovery.

3. Governor Romney wins and implements a pro growth agenda, but the current situation is too urgent to wait for actions that won’t take effect until at least next spring and summer.

Today, in August, businesses are already curtailing investments in machinery and information technology, as a hedge against a contracting economy in 2013, and consumers are spending less. Retail sales fell each of the last three months.

The Great Recession was caused by manifest structural problems in the economy: a wide trade gap with China and on oil; banks that had forgotten how to earn profits through sound lending; failed financial regulations and skyrocketing health care costs.

President Obama’s policies have mostly exacerbated those problems. That’s why the recovery is so weak, and a second recession now could put the economy down for good.

Too many young adults unemployed or in poorly paying jobs are living with aging parents. Many older Americans are running down IRAs before reaching retirement age, hoping for better days.

The safety nets provided by parents and savings will soon tear. If the economy goes down again, the negative feedback cycle of fewer jobs, less spending, more layoffs, and so forth will be much more severe than in 2008.

The hallmark of a depression is a recession that does not sow the seeds of recovery by creating pent up demand for business and consumer durable goods. Truck and car replacements played a mighty role in our most recent, albeit weak, recovery.

With many Americans slipping from the middle class, businesses may simply downsize for a permanently smaller U.S. economy, and families will own fewer vehicles, appliances and electronic toys. Unemployment in the range of 15 percent easily could become the new normal.

President Obama should risk upsetting his base and offer Republicans in Congress a reasonable deal now.

Republicans should admit what they already know—Mitt Romney is no messiah—and take the risk of compromising now.

American can’t afford for their elected officials to dither any longer.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.

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