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Could fiscal cliff spark stimulus?

December 3, 2012: 3:31 PM ET

fiscal_cliffFixing the fiscal cliff isn't just about avoiding disaster.

FORTUNE -- Most everyone believes that America will become recessionary if we fall off the fiscal cliff in 28 days. What has gotten less attention, however, is what might happen were Washington to actually get its act together.

I'm not talking about how taxes might rise for some and not for others, or how particular programs might be cut or saved. Instead, I'm simply talking about the notion that a deal -- any deal -- pass through Congress and get signed by President Obama's famous pen. Would such an agreement not only prevent recession, but actually prove stimulative?

That's the thesis of Jason Thomas, director of research at private equity firm The Carlyle Group (CG).

Thomas today published a paper arguing that a credible fiscal cliff resolution would finally prompt corporate America to begin investing its record cash hoards. Even if corporate taxes were to rise.

"A lot of CEOs are risk-adverse and part of that is behaving as if it's going to be the worst-case scenario," Thomas explained in a phone call. "But if what comes out is even mildly better than they anticipated, then they could begin making investments. It also would give them some confidence that our government has the ability to function."

From the paper:

"Q1-2010 marked the first time in history that corporate profits exceeded business fixed investment. Unlike prior cycles where an increase in corporate profits led to faster investment growth as cash was reinvested in plant and equipment, business investment has increased very modestly since 2009 even as corporate profits have nearly doubled as a percentage of GDP. Were businesses simply to reinvest cash flow at historic rates, fixed investment would add nearly 4% to GDP ($695 billion) by the end of 2016 and more than offset the fiscal drag from reduced disposable personal income."

To be sure, Thomas is largely rehashing the uncertainty argument that I find so asinine. But, if he's right, then we could be talking about the fiscal cliff representing much more than a six point swing from (nearly) 3% GDP to -3%. Instead, it could be a 10-point swing.

Thomas also rejects arguments that America would be better off, in the long-run, by going off the cliff. He believes that the short-term effects could be so damaging that they could change the baseline assumptions going forward. "You have the potential for a real confidence shock, and then there's the debt limit that's going to have to be raised," he says. "If you reach an impasse, the prediction of 3% contraction could be optimistic."

Also worth noting that Thomas' employer seems to be betting on a deal. The firm committed to invest $4.4 billion of equity in the first three quarters of 2012, almost two-thirds of which was in industrial or manufacturing plays. It also has developed a reputation for being the top bidder in several competitive situations.

Part of this activity is prompted by debt market conditions, but those aren't unique to Carlyle. If the firm believed there was a strong chance of shock recession -- and the aforementioned long-term repercussions -- then it probably wouldn't be making so many new deals.

Thomas declined to comment on Carlyle's investment decisions, as he is not a part of them.

Here is the entire paper:

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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