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Over the past month, fiscal cliff has dominated the financial markets’ grapevine, and for good reason. Coming up with a permanent solution has been postponed time and again, with politicians settling for temporary, band-aid deals.

This time though, it looks as if they want to lay the groundwork for a plan that will provide a long-lasting solution.

Keep in mind, my young padawans, that if a deal isn’t made, Uncle Sam will be headed for tons of automatic spending cuts, and this could severely hamper the economy from gaining any momentum.

This past weekend, two big men went head-to-head to get the ball rolling on the fiscal cliff issue. U.S. President Barack Obama and House Speaker John Boehner – essentially representing the Democratic and Republican parties, respectively – talked for just less than an hour and presented their respective cases.

After weeks of refusing to give in to calls for higher tax rates across the board, Boehner finally loosened his demands and agreed to a tax rate increase for households earning more than 1,000,000 USD from 35% to 39.6%. In his proposal, Boehner said that this should raise revenue by 1 trillion USD.

However, Boehner also asked that any increase in tax rates should be offset by spending cuts by the government. He wasn’t gonna give in to tax rate increases without asking for something in return!

On the other side of the table, Obama made some concessions of his own.

After initially asking for tax increases for those making more than 250,000 USD, Obama counteroffered and is now requesting increases for households in the 400,000 USD and above brackets.

Under his deal, this would increase tax revenues by 1.2 trillion USD. His plan would also include permanently extending many tax breaks that are scheduled to end, but will also achieve 1.13 trillion USD worth of savings across health, defense, Social Security, and other government programs.

Naturally, as currency traders, we’d like to know how the U.S. fiscal cliff might affect the dollar moving forward. After all, what good is all this info and analysis if we can’t put it to use, right?

USDX Chart

So what’s it gonna be for the USD – will it chalk up more losses or will it stage a comeback?

The way I see it, there are three possible ways this could play out:

  1. If a deal is made before the end of the year, I imagine it would slightly revive interest in the dollar, as it would help tame one of the biggest threats to the economy.
  2. If lawmakers don’t come to an agreement and the U.S.’s automatic budget cuts kick in, it will most likely lead to a tougher time for the U.S. economy in 2013 and a potential debt downgrade down the line. Hence, demand for the dollar will probably subside.
  3. Lastly, if U.S. lawmakers manage to come up with a temporary deal to appease both sides for the meantime, we could just end up having to go through this whole charade again next year. In that case, the dollar will probably just trade sideways over the next few months as the markets await another day of reckoning.