US teeters on edge of fiscal cliff

This week Boehner said he had “frank conversation” about the gulf in his position with Obama, saying that the President’s plan didn’t go far enough to tackle the federal deficit.

The Republicans believe that the fiscal cliff can be lowered by simply closing tax loopholes or capping deductions, not by direct increases in taxes – a plan ridiculed by the White House.

“Those magic beans are just beans, and that fairy dust is just dust,” said White House spokesman Jay Carney in response.

The Republicans want to cut government spending by $1.4 trillion, raising the eligible age for Medicare healthcare for the elderly from 65 to 67 and adjusting how annual increases in Social Security payments are calculated for welfare recipients.

Flush with victory in the presidential election, Democrats are loath to consider reforms within major government spending programmes as part of the negotiations.

Any hope that the Federal Reserve could rescue the situation were dashed this week when its chairman Ben Bernanke warned that bond-buying, effectively printing money by the central bank, would not offset the economic damage if politicians fail to reach a deal to close the $1 trillion federal deficit.

The Fed is already taking extraordinary action in its efforts to keep the US economic recovery on track. This week the central bank said that it would buy a further $45 billion of government bonds every month on top of the $40 billion of mortgage debt that it is already buying.

It even took the unprecedented step of signalling that interest rates would remain near zero until unemployment falls to at least 6.5 per cent from the present level of 7.7 per cent.

Against that backdrop, there is a growing acceptance among Republicans that they must reluctantly swallow tax increases but they are still holding out for spending reforms in exchange.

Democrats may, as part of a deal to avoid the “cliff”, push for agreement on the longer-term problem of the $16.4 billion debt ceiling, which is just $67 billion of debt away and is likely to be hit in mid-February.

Political posturing over how the split between spending cuts and tax hikes will ultimately fall in a deal may push negotiations right to the wire and the threat of a self-inflicted recession will increase the pressure on both sides to reach a compromise.

In the meantime, the ugliness of political battle between a Democratic White House and Republican Congress will be a taste of the challenges to come for Obama in his second term.

“It is a huge test,” said a US diplomatic figure. “If they fail to reach a deal, there are going to be big questions about governance and if politics cannot take a split, there will be terrible implications.”