A mentor and old cold warrior once told me a tale about a young boy who, every day, rode a bicycle through a security checkpoint along the border of a war-torn Middle Eastern country. The guards grew ever more suspicious and, in a futile effort to look for contraband, began to randomly cut open the sandbags the boy always had strapped across the back of his bike. After a few months, the guards faced the boy down and said: "Look kid, we know you're stealing something. So admit it now and we'll let you go. What is it?" The boy, sweating profusely, replied: "Bicycles."
The lesson here is that there is often much going on, right beneath our noses, that no one discusses. This is surely the case with regard to the tiresome "fiscal cliff" coverage in the media.
Specifically, while it seems 95% of news stories have focused primarily on Republicans' resistance to tax hikes, all but ignored has been the hardening of Democrats' resistance to mandatory spending and entitlement cuts -- an unavoidable ingredient in any short- or long-term deal.
For example, in a speech Tuesday, Senate Majority Whip Richard Durbin (D-IL) said Medicare reforms should not be a part of any year-end deal to avoid sequestration and lapsing of the Bush tax cuts. That was even as he reiterated that these reforms should be part of an eventual grand bargain. Yet, at the same time, President Obama and his fellow Democrats are demanding the immediate restoration of the top two Clinton-era tax brackets for those making more than $250,000, a move that would generate $800 billion or more in revenue over the next 10 years.
Alternative routes to reach similar savings exist, but the president has the most leverage here, since going over the cliff will force tax increases, and not entitlement cuts. His campaign supporters, rather than standing down, have been casting Republicans as the only ones standing in front of tax relief for the other 98%. In fact, Obama is trying to project common cause with CEOs and small businessmen, who desperately just want to avoid a recession.
Meanwhile, on the GOP side, from where will the trade-off come in the next 30 days concerning any concession of such a magnitude? After all, the Democrats are not-so-subtly attempting to shrink, if not invert, the targeted goal of a 3-to-1 ratio on spending cuts to tax hikes. This was the proportion previously established by the congressional Simpson-Bowles commission for any "balanced" deficit reduction plan.
As my colleague Jim Lucier argues, the obsession with anti-tax advocate Grover Norquist has obscured the fact that the White House has forwarded no serious plan for spending cuts. Meanwhile, the seemingly dissenting GOP voices of Sens. Lindsey Graham (R-SC) and Saxby Chambliss (R-GA), as well as Rep. Peter King (R-NY), hardly seem to represent a sharp division in the Republican Party. They have all sought television coverage in public feuds with Norquist before, and even they have continued to draw a distinction between higher rates and more revenue via tax reform.
There's been a bit more head-scratching after Tuesday's news that Rep. Tom Cole (R-OK) urged fellow members of the House GOP caucus to go along with Obama's demanded tax hike on the top 2%, ostensibly in order to maintain leverage in a broader tax fight next year. But, for the most part, House Republican lines have held remarkably well. Even if the GOP were ready to cave on taxes, they'd hardly do it in a vacuum, without demanding major accompanying spending cuts to -- perhaps the true "long pole in the tent" amid rising post-election expectations on the political left.
This portends the two sides talking past each other before they finally agree to a last-minute agreement that's short term in nature, purely in order to avoid the cliff and potential market turbulence at year-end. But perhaps most worrisome is the threat this could present to the sanguine conventional wisdom that any deal may immediately unleash a big market rally.
Put simply, even before the initial and superficial smiles have faded, we're seeing the poisoning of the well for a longer-term deal next summer or fall. If the president continues to ramp up his public campaigning, rather than becoming more involved in facilitating a deal, there's little prospect that the scope of any year-end agreement -- or reach of bipartisan bonhomie -- will accommodate any measurable extension of the debt ceiling. That extension can't be avoided much past late winter. The whole matter will add a whole new (and negative) meaning to Hill Democrats' strategic description of a seemingly bearable "fiscal slope," rather than cliff.
Yes, there are signs of a potentially durable market rebound that have recently excited the bulls. But, despite this, in essence we could find market sentiment gradually slipping amid uncertainty that might not let up at Christmastime, as expected, but instead could continue past New Year's -- if not deep into 2013.
It's hard to see how that wouldn't eventually force investors into the "Mercutio Market" crouch I've described as signaling "a plague on both political parties' houses." So I increasingly think it's important that investors wait not only for any big commitments on signs of an initial deal, but also for evidence regarding the quality of any such agreement.