Economic Armageddon

AS THELMA SAID TO LOUISE, "THERE IS A POINT BEYOND WHICH WE CANNOT RETURN."

AHEAD OF THE CURVE

Last Update: 29-Jan-13 08:58 ET

The Real Battle In Washington

The real battle in Washington is not the debate over the debt ceiling. Everyone knows that it will be raised eventually. The real battle is whether the deficit is important – or not. 

If The Debt Ceiling Is Not An Issue 

The debt ceiling seems like it would be an important issue, but only if you embrace the idea that deficit spending is both dangerous, at excessive levels, and should be minimized, at least over time. 

If, for example, a core belief is that deficit spending can continue indefinitely, then the debt ceiling is simply a matter of paperwork. 

This seems to be the negotiating position of President Obama currently, on the deficit ceiling. 

The Republicans have been trying to use the impending debt ceiling as a negotiating bargaining chip. 

However, President Obama has realized that the Republicans have virtually no negotiation leverage with the debt ceiling. 

After all, if President Obama refuses to negotiate spending issues as part of raising the debt ceiling, it is virtually certain that the Republicans would be blamed for any default that the US might incur on unpaid debt. 

President Obama, with the help of the media, would be able to position any default as one that would be the Republicans fault. He might even be willing to let the US default if it could be clearly blamed on the Republicans. After all, the default would likely be temporary. 

If so, President Obama might be able to use this as leverage against Republicans in the 2014 elections. 

In fact, President Obama has little to lose in refusing to make spending reduction an issue in Washington.  

The Republicans have been slow to realize this, but that is because President Obama, who was once critical of the Bush administration’s deficit spending, actually does not seem to feel that deficit spending is a problem to be addressed. 

If Deficit Spending Is Not A Problem  

Who believes that deficit spending is not an issue? 

The leading public advocate of the benefits of deficit spending is Paul Krugman, Nobel Prize winning economist and a devote supporter of the Obama administration. 

Mr. Krugman has argued for a long time that the solution to the slow economy is even more deficit spending than has been done before. His main criticism of the stimulus spending of 2009 and 2010 has been that it was far too small. 

The question of how such spending is necessary to actually produce economic growth never seems to be brought up, but Mr. Krugman is adamant that the stimulus spending to date has not been enough. 

President Obama’s View 

The real question in the deficit spending debate is whether President Obama views the deficit as a problem. 

In the past, he was a vocal critic of the Bush administration’s deficit spending. 

In 2006, then Senator Obama made the following statement, when a vote on raising the debt ceiling: 

“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.”

However, today, President Obama has been encouraging increased investment in education, infrastructure, without any reductions in spending for persons who receive government aid. 

This essentially could be interpreted to mean that President Obama does not really care about deficit spending, but without any recent  clear statements on whether he views deficit spending as an issue or not it is hard to speculate. 

We tend to think that President Obama is now more concerned with leaving his own personal lasting imprint upon the Presidency – and America – than he is with bring financial disciplines to Washington. 

If anything, President Obama probably believes that increased taxes are enough to keep deficit issues at bay. 

This was certainly his rallying call during the election process, when he repeatedly stressed the idea that the “rich should pay their fair share.” 

While such a viewpoint was a powerful campaign issue, as it aroused emotions, from a financial perspective, it was relatively minor. 

As we pointed out in an Ahead of the Curve column dated December 5, 2012 “The Absurdity Of The Fiscal Cliff Debate”, the argument over taxation of incomes over $250,000 only amounted to $42 billion worth of revenue in 2013 (assuming no change in behavior by taxpayers due to the new rates). 

What this meant is that the issues of deficit spending got swept under the rug of financially insignificant emotional issues during the campaign. 

This leaves the question of President Obama’s view on deficit spending largely unknown right now. 

It certainly doesn’t seem to be of the same importance as it is to Republicans.  

What this all means for the budget negotiations in the upcoming year is unpredictability. 

Does It Matter? 

So far, the markets have seemed to tolerate unpredictability in Washington’s fiscal direction, but we wonder how long such a patience will last. 

It is beyond the scope of this single article to discuss why deficit spending is an issue that must be addressed somehow. 

We have long argued that both new revenues and spending cuts must be addressed in order to avoid a runaway financial situation. 

The real problem is that deficit spending becomes an important issue when the purchasers of US debt begin to make demands on the social structure of the US. 

This is what has caused the turmoil  in Greece in recent years.  

There is an argument that the US could never become Greece, but if purchasers of US debt began to demand 7% interest rates, as purchasers of Greek debt did several years ago, the US might well lose control of the financial future.  

To rescue Greece, the European Union began to make demands on Greece to bring the annual deficit spending to a “realistic” level of 3% of GDP. 

The US currently has run a deficit spending of almost 10% of GDP for four years. 

The long term future of the US depends upon the credibility of the US dollar in the rest of the world. 

Extensive deficit spending slowly weakens that position over time. While we haven’t reached the critical point were confidence collapses, and a shift to some other global currency as the standard occurs, we are headed in that direction.  

How far away from the point we are, is unknown. 

The problem, of course, is that once the critical point of confidence in the US dollar is breached, it cannot be easily recovered. We can only hope that the political divisiveness in Washington doesn't bring us so close that we slip over the edge without intention from either side of the political argument. 

Comments may be emailed to the author, Robert V. Green, at aheadofthecurve@briefing.com 

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I Want A Divorce!

DIVORCE AGREEMENT

Dear American liberals, leftists, social progressives, socialists, Marxists and Obama supporters, et al:

We have stuck together since the late 1950's for the sake of the kids, but the whole of this latest election process has made me realize that I want a divorce.

I know we tolerated each other for many years for the sake of future generations, but sadly, this relationship has clearly run its course.

Our two ideological sides of America cannot and will not ever agree on what is right for us all, so let's just end it on friendly terms.

We can smile and chalk it up to irreconcilable differences and go our own way.

Here is a our separation agreement:

Our two groups can equitably divide up the country by landmass each taking a similar portion.

That will be the difficult part, but I am sure our two sides can come to a friendly agreement.

After that, it should be relatively easy!

Our respective representatives can effortlessly divide other assets since both sides have such distinct and disparate tastes.

We don't like redistributive taxes so you can keep them.

You are welcome to the liberal judges and the ACLU.

Since you hate guns and war, we'll take our firearms, the cops, the NRA and the military.

We'll take the nasty, smelly oil industry and the coal mines, and you can go with wind, solar and biodiesel.

You can keep Oprah, Michael Moore and Rosie O'Donnell.

You are, however, responsible for finding a bio-diesel vehicle big enough to move all three of them.

We'll keep capitalism, greedy corporations, pharmaceutical companies, Wal-Mart and Wall Street.

You can have your beloved lifelong welfare dwellers, food stamps, homeless, homeboys, hippies, druggies and illegal aliens.

We'll keep the hot Alaskan hockey moms, greedy CEO's and rednecks.

We'll keep Bill O'Reilly, and Bibles and give you NBC and Hollywood .

You can make nice with Iran and Palestine and we'll retain the right to invade and hammer places that threaten us.

You can have the peaceniks and war protesters.

When our allies or our way of life are under assault, we'll help provide them security.

We'll keep our Judeo-Christian values.

You are welcome to Islam, Scientology, Humanism, political correctness and Shirley McClain.

You can also have the U.N. but we will no longer be paying the bill.

We'll keep the SUV's, pickup trucks and oversized luxury cars.

You can take every Volt and Leaf you can find.

You can give everyone healthcare if you can find any practicing doctors.

We'll continue to believe healthcare is a luxury and not a right.

We'll keep "The Battle Hymn of the Republic" and "The National Anthem."

I'm sure you'll be happy to substitute "Imagine", "I'd Like to Teach the World to Sing", "Kum Ba Ya" or "We Are the World".

We'll practice trickle-down economics and you can continue to give trickle up poverty your best shot.

Since it often so offends you, we'll keep our history, our name and our flag.

Would you agree to this?

If so, please pass it along to other like-minded liberal and conservative patriots.

In the spirit of friendly parting, I'll bet you might think about which one of us will need whose help in 15 years.

Sincerely,

John J. Wall
Law Student and an American

P.S. Also, please take Ted Turner, Sean Penn, Martin & Charlie Sheen, Barbara Streisand, & (Hanoi) Jane Fonda with you.

P.S.S. And you won't have to press "1" for English when you call our country.

Forward This Every Time You Get It ! Let's Keep This Going, Maybe Some Of It Will Start Sinking In!!

Doug Kass Predicts 2013

Have a look at the following article by Doug Kass to learn what 2013 has in store for us:

Doug Kass: 15 Surprises For 2013

Wisdom For The Ages

1. In my many years I have come to a conclusion that one useless man is a shame, two is a law firm, and three or more is a congress. -- *John Adams*

2. If you don't read the newspaper you are uninformed, if you do read the newspaper you are misinformed. -- *Mark Twain* 

3. Suppose you were an idiot. And suppose you were a member of Congress. But then I repeat myself. -- *Mark Twain*

4. I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle. --*Winston Churchill*

5. A government which robs Peter to pay Paul can always depend on the support of Paul. -- *George Bernard Shaw*

6. A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money. -- *G. Gordon Liddy*

7. Democracy must be something more than six wolves and a sheep voting on what to have for dinner. --*James Bovard, Civil Libertarian (1994)

8. Foreign aid might be defined as a transfer of money from poor people in rich countries to rich people in poor countries.-- *Douglas Case* (Classmate of Bill Clinton at Georgetown University)

9. Giving money and power to government is like giving whiskey and car keys to teenage boys.-- *P.J. O'Rourke*, Civil Libertarian

10. Government is the great fiction, through which everybody endeavors to live at the expense of everybody else. -- *Frederic Bastiat*, French economist (1801-1850)

11. Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. --*Ronald Reagan * (1986)

12. I don't make jokes. I just watch the government and report the facts. -- *Will Rogers* 

13. If you think health care is expensive now, wait until you see what it costs when it's free!-- *P. J. O'Rourke* 

14. In general, the art of government consists of taking as much money as possible from one party of the citizens to give to the other. --*Voltaire * (1764) 

15. Just because you do not take an interest in politics doesn't mean politics won't take an interest in you! -- *Pericles* (430 B.C.) 

16. No man's life, liberty, or property is safe while the legislature is in session. -- *Mark Twain * (1866) 

17. Talk is cheap, except when Congress does it. -- *Anonymous* 

18. The government is like a baby's alimentary canal, with a happy appetite at one end and no responsibility at the other.-- *Ronald Reagan* 

19. The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery. -- *Winston Churchill* 

20. The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin.-- *Mark Twain* 

21. The ultimate result of shielding men from the effects of folly is to fill the world with fools.-- *Herbert Spencer*, English Philosopher (1820-1903) 

22. There is no distinctly Native American criminal class, save Congress. -- *Mark Twain* 

23. What this country needs are more unemployed politicians -- *Edward Langley*, Artist (1928-1995) 

24. A government big enough to give you everything you want, is strong enough to take everything you have. -- *Thomas Jefferson* 

25. We hang the petty thieves and appoint the great ones to public office. -- *Aesop*

FIVE BEST SENTENCES 

1. You cannot legislate the poor into prosperity, by legislating the wealthy out of prosperity.

2. What one person receives without working for, another person must work for without receiving.

3. The government cannot give to anybody anything that the government does not first take from somebody else.

4. You cannot multiply wealth by dividing it.

5. When half of the people get the idea that they do not have to work, because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that is the beginning of the end of any nation!

Fiasco Summary

THE BIG PICTURE

Last Update: 02-Jan-13 13:36 ET

Congress Strikes a Deal That Isn't Done

You have probably heard by now that Congress reached a deal to avert the fiscal cliff. The process of getting there wasn't pretty, which was no surprise, and the end result was less than expected, which was also no surprise. The stock market's initial response to the deal has been decidedly bullish. Again, that is not a surprise.

While we typically post The Big Picture on Monday, the developments in Washington have mandated a post today.

To be succinct, we understand why the stock market is rallying today even if we don't exactly understand what all of the hoopla is about. The deal that got done was another silly, last-minute drama scripted by Congress that dealt with tax rates, but essentially kicked the can down the road with respect to needed spending cuts and entitlement reform.

Deal Provisions 

The main provision of the deal calls for the income tax rate to go up to 39.6% for individuals making more than $400,000 a year and households with a combined income of more than $450,000. The lower tax rates below those income thresholds will be made permanent. Other provisions include:

• A bump in the capital gains and dividend tax rates from 15% to 20% for individuals making more than $400,000 a year and households making more than $450,000 a year 
• A one-year extension of unemployment benefits for the long-term unemployed
• A two-month delay in the $109 bln sequestration, which forced discretionary and non-discretionary spending cuts
• A permanent fix for the alternative minimum tax
• An increase in the estate tax from 35% to 40%, with the first $5 mln exempt for individual estates
• A five-year extension of the child tax credit, the earned income tax credit, and the tax credit up to $2500 for college tuition
• A one-year extension of the tax credit for R&D costs and the tax credit for renewable energy 
• A one-year provision that allows businesses to write off 50% of new investments immediately
• A one-year deferral of the 27% cut in Medicare payments to doctors 

It is estimated that $600 bln in new revenue will be raised over 10 years.  According to the non-partisan Tax Policy Center, $199 bln in new tax revenue will be collected in 2013.

First, the Good News

The good news, economically speaking, is that income tax rates are not going to increase for 99% of taxpayers.  That realization is at the heart of today's stock market rally.  All else equal, it is a compromise component that will prevent the economy from slipping back into a recession.

Things rarely turn out to be equal, though, so we can't categorically rule out the possibility that the US economy will slip into a recession this year.

We digress.

The other good news, relatively speaking, is that the maximum capital gains and dividend tax rates for high-income earners only went from 15% to 20% (it will end up being 23.8% after the surcharge to help pay for the Affordable Care Act).  There were concerns the dividend tax rate could be set at the highest tax rate for high-income earners, or 43.4% after the surcharge is included.

There are two benefits, therefore, tied to the capital gains and dividend tax rates: (1) there is the certainty of knowing what the rate will be and (2) the rate is not nearly as high as some participants feared it might be.

The latter consideration in particular should be regarded as a positive for dividend-paying stocks.

The accelerated depreciation and the extension of the tax credit for R&D costs were added bonuses for businesses.

...And Now the Bad News

Even though income tax rates will not be going up for the vast majority of taxpayers, all private-sector workers will see the rate on their Social Security payroll tax revert to 6.2% from 4.2%.   For a worker making $50,000, that amounts to $1,000 more coming out of his or her paycheck this year versus last year.

Another negative is that we don't think businesses are necessarily going to feel inspired to start spending liberally and hiring more aggressively. 

The tax rate headlines might sound good, but the fact of the matter is that the expiration of the lower Social Security payroll tax and the imposition of higher tax rates for high-income earners will be a drag on the economy by reducing personal consumption.  That's one issue. 

The other issue is that Congress and the White House are going to be battling again very soon on spending cuts, entitlement reform, and the debt ceiling.  They shouldn't be intertwined, yet they will be since the debt ceiling is going to be used as leverage by the GOP for extracting spending cuts. 

President Obama has already said he won't negotiate around the debt ceiling, so it is pretty clear that battle lines are being drawn and that the next few months in Washington could be a bloody mess on the legislative front.

That means political uncertainty will continue to act as a deterrent, or simply a convenient excuse, for businesses to defer spending decisions.   At the same time, it will pose a real risk of another downgrade to the US credit rating that could roil capital markets.

Bad Is Better than Worse

With the deal that got done, the prospect of a worst-case recession scenario was reduced to a bad scenario of lower economic growth.  Accordingly, the equity risk premium has come down in response to the tax rate compromise since bad is better than worse.  It's a relative assessment, yet all things are relative for equity market participants.

In that regard, longer-dated US Treasuries are getting clipped pretty good today, but perhaps not as much as one might think if there was a sense that Congress provided market participants with a true solution versus a shotgun compromise on the political chip every voter can relate to -- income tax rates. 

The 10-year Treasury note is down 21 ticks.  It's a notable drop, but it's not a head-for the-safe haven exit kind of move.

There is more work to be done in Washington to reduce our deficit and debt -- a lot more work.  That is a daunting thought for a variety of reasons and it is a sobering reminder to keep one's enthusiasm in check over the deal that got done, which was really only a half deal that garnered 167 "No" votes in the House of Representatives.

What It All Means 

The equity market has started the new year on a banner note, but the next few months could be fairly turbulent as fourth quarter earnings are reported and as the debate over spending cuts unfolds in public fashion.

The battle over spending cuts is setting up to be even more acrimonious than the battle over tax rates.

With that in mind, we feel compelled to reiterate our view that a blended investment strategy for the equity component of one's portfolio could make sense entering 2013. 

That is, don't overweight or underweight cyclical and countercyclical sectors exclusively. 

Maintain a balanced mix, as that will allow for participation in upside moves like the one seen today and help mitigate losses in down markets that might be seen in the near future if partisan politics takes us to the brink again of possibly defaulting on our debt, which is at $16.3 trillion and counting.

--Patrick J. O'Hare, Briefing.com