1/7/2013 9:15 PM ET|
Forget the cliff; beware the ceiling
For all the worry, the fiscal cliff was just a preview of the debt-ceiling ruckus ahead. Here's why that could be worse for investors -- and how to get through it.
You ain't seen nothin' yet.
The cliffhanger of a fiscal cliff deal was just a dress rehearsal for the late-January/early-February battle over raising the debt ceiling. This time it's worse -- and more worrisome for investors. This one could really move global markets -- and move them fast and hard, in the not-so-distant future. Here are three reasons why, plus a strategy for getting past it.
The crises ahead
This time the damage from missing the deadline for a deal sets in on Day One. The negative effects of not reaching a fiscal cliff deal on taxes and spending on Jan. 1 or thereabouts was never going to be immediate. In the fiscal cliff crisis, tax rates indeed would have gone up immediately, but tax payments would have increased gradually and spending cuts would have been phased in over time. The damage to the U.S. economy from a fiscal cliff failure would have been major -- perhaps enough to send the economy back into recession -- but it would have been felt only gradually. That's why economists, Wall Street pundits and politicians kept saying that it was possible to go over the cliff and still fix the problem before the economy suffered major damage. (This was the so-called bungee-cord strategy.)
That's not true of the debt-ceiling crisis. This time, the damage is likely to be big and immediate, and some of it won't be easily reversed.
This crisis is really three crises in one:
- Crisis No. 1 is the raising of the debt ceiling. If Congress doesn't raise the current $16.4 trillion debt ceiling, the Treasury can't increase net borrowing to pay the country's bills. In practice, the Treasury has ways to manage the country's debt levels so that it can pay U.S. obligations until, according to estimates from the Congressional Budget Office, mid-February. After that, the Treasury would have to decide to pay some bills and not others. You can bet it would continue to pay the interest on U.S. debt, even if it had to raid other budget lines to do so. Default on U.S. debt obligations would throw the U.S. and the rest of the world into financial market chaos.
- Crisis No. 2 hits shortly after the Treasury runs out of room to finagle. The fiscal cliff deal put off $1.2 trillion in automatic spending cuts divided equally between defense spending and domestic discretionary spending -- this is what's called the sequester -- that were set to gradually take effect after Jan. 1, according to the terms of the Budget Control Act of 2011, which ended the most recent battle over the debt ceiling. (About $100 billion in automatic cuts would go into effect in the 2013 fiscal year that ends on Sept. 30.) The Jan. 1 fiscal cliff deal postponed the cuts until March 1. So, sometime in the next six to seven weeks, Congress will have to resolve the automatic budget cuts it has failed to address in a meaningful way in the past 18 months or so. Otherwise, federal spending gets whacked by $100 billion this year -- with more cuts to come. That's certainly enough to take a bite out of first-quarter growth in gross domestic product that economists already fear could dip to a rate of just 1%.
- Crisis No. 3 comes close on the heels of Crisis No. 2. The September 2012 continuing resolution that authorized spending by the federal government expires March 27. Unable to pass an actual budget or the appropriation and spending bills that go with it, our government in Washington has been operating under a continuing resolution that authorized spending for the first half of fiscal 2013. Unlike a failure to raise the debt ceiling -- which would lead to the government paying some bills and not others -- failure to extend the continuing resolution would mean that the federal government wouldn't have authority to spend any money. Here, we're looking at something that would actually shut down the federal government.
The two sides have already begun to double-down on their rhetoric. Congressional Democrats, afraid that President Barack Obama will negotiate spending cuts on entitlements including Social Security and Medicare, are urging the president to get tough. House Minority Leader Nancy Pelosi, D-Calif., has said the president should invoke the 14th Amendment to raise the debt ceiling by presidential order. Section 4 of that amendment says, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned." Some constitutional lawyers -- along with some Congressional Democrats and some members of the Obama administration including Treasury Secretary Timothy Geithner -- have argued that this language makes the debt ceiling itself unconstitutional and gives the president the power to simply raise or ignore the debt ceiling. (So far, the White House, aware that such an assertion of power would provoke a constitutional crisis, has said it does not intend to invoke the 14th Amendment.)
On the Republican side, Senate and House leaders facing a revolt by conservative Republicans have declared any further tax increases off the table. On Sunday, Republican Senate Minority Leader Mitch McConnell of Kentucky said, "The tax issue is finished, over, completed." That will come as a surprise to a White House that is holding to its position that any spending cuts must be balanced 1-to-1 by tax increases. Such extreme positions seem to mark the beginning of negotiations in Washington these days. And the distance between these positions, even if they are rhetorical posturing, is certainly enough to make reaching any agreement a long and drawn-out affair with big potential to worry the market.
What the market fears
That potential to worry the market is what interests investors most. Here's how I'd handicap that worry.
From the fiscal cliff deal, we know that investors are inclined to assume that, against all evidence, politicians will find a compromise rather than wreck the economy or destroy the U.S. credit rating. I think in this case that means that the markets are likely to stay relatively optimistic until at least the fourth week in January.
How do I arrive at that? The next meeting of the Bank of Japan is set for Jan. 21 and 22, and the next meeting of the U.S. Federal Reserve's Federal Open Market Committee is Jan. 29 and 30. The Bank of Japan is widely expected to cave in to pressure from the newly elected Liberal Democratic government and announce a big program of bond buying that would push inflation toward a goal of 2% and weaken the yen. Investors will be looking to the Fed meeting for signs that, after the fiscal cliff deal and with the looming uncertainty of the three February crises, the bank intends to keep its $85 billion-a-month program of economic stimulus (via quantitative easing) running at full throttle.
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I think investors will be reluctant to do much selling of stocks and bonds before those dates, especially since Asian financial markets are likely to be strong over the next two weeks on hopes for Japanese stimulus and on evidence that China's economic growth is accelerating.
After that, though, global financial markets will be free to focus on the news out of Washington. I expect that news to be negative -- I don't think we'll see a deal until the very last minute, again. And I expect that Wall Street gurus and the companies that rate government debt -- Standard & Poor's, Moody's Investors Service and Fitch Ratings -- will keep reminding financial markets about the possibility of another downgrade to the current AA U.S. credit rating. Granted, the last downgrade didn't produce any increase in U.S. interest rates or a weaker dollar, but that was largely because the eurozone debt crisis made the United States an attractive safe haven. The United States doesn't have that going for it this time, since the eurozone has temporarily "solved" its crisis.
I don't know if this publicized uncertainty will be enough to end the recent rally and produce a significant sell-off in financial assets.
I do know that the next crisis will be enough to increase the odds of a sell-off, especially since stocks have rallied to five-year highs. As I've written recently (See "7 steps to investing success in 2013.") if you want to profit from the recent rally, you need to do it sooner rather than later. Before the end of the month, I think the odds will have shifted, reducing potential reward and increasing potential risk.
Given the nature of the debt-ceiling crisis, in which fears of a credit downgrade for the United States would hit both U.S. stocks and bonds (and, if it got scary enough, extend downward pressure to Asian and other emerging markets), cash strikes me as the best asset in the crisis. (Gold would normally be a safe haven, too, but gold has been in its own downtrend recently, and, for the moment, I prefer cash.)
How much do you want to move to cash? I'd use the rules I laid out in a recent post on Jubak Picks to increase cash holdings. As of this moment, I see any crisis-related downturn as a buying opportunity that I'd like to have enough cash -- say 20%? -- to exploit rather than as a reason to sell everything. Watch our politicians -- and global market reaction to our politicians -- to see if that changes.
You certainly can't say this is a dull market.
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On the defense side, there are programs/systems the military DOESN'T want, but are essentially earmarks for a district of a particular Congress man/woman.
On the corporate welfare side, farm subsidies for large farms (not family owned), subsidies for the oil companies, the ethanol subsidies, the subsidy for the Medicare HMO's (they get a 15% markup just to take Medicare patients).
On the individual welfare side, ending extended unemployment, AFDC beyond two years, housing subsidies. Keep subsidized school lunches for the kids, but if their parents want to eat, they have to work.
A combination of the above makes more sense than just focusing on one thing. You'll need a combination for the figures to add up.
I say that both the Dems and Repubs are both irresponsible and stupid. Taxes need to go up AND spending needs to be cut, although I lean more towards spending needing to be cut. I also think tariffs should be used (among other tactics) to reverse the "sucking sound of American jobs being lost" that Ross Perot warned us about in 1992. I'm more afraid of the current "trade surrender" than a trade war that we as a NET IMPORTER might face.
The Republicans used to be a respectable and responsible party, moreso perhaps in the Barry Goldwater through Nixon-era. Dirty tricks aside (Watergate etc), Nixon was a competant leader (started really putting the hurt to North Vietnam compared to LBJ tho too little too late, opened China -- without going too far like Clinton) and creating the EPA.
The Democrats' political whoring tactic of robbing Peter to pay Paul in order to get Paul's vote pushed the Republicans to desperation by the Reagan era, pushing the Republicans into becoming pimps for the fossil fuel industries and Jesus in order to survive, and making the Republicans adopt the Democratic tactics of fiscal irresponsibility (more so by deficit spending than raising taxes).
And thus we get the current generation of incompetant leaders (internationalists, globalists, neo-cons, etc) like Bill Clinton, George W. Bush and Obama. Neither OWS nor the Tea Party have a clue. The truth is this country was not founded on Big Government OR Big Business and Big Business is just as bad. Just ask the Original Tea Partiers what they thought of the British East India Company's monopoly on tea.
Also small businesses tend by their nature to export less jobs to China and India. Ironically and somewhat counterintuitively, greater regulations gives Big Business an edge over Small Business.
The good thing is the liberals don't believe in or own guns. The socialists however do, and use them.
The socialists believe in big government. They don't believe in 'rights' they believe government can take away rights.
Liberals believe, like marx, those according to their ability, those according to their need. They believe government should seize from the those that work by tax or bayonet what the workers earn, and that government should then redistribute this to those that vote for socialism.
This why the leech class has grown by leaps and bounds. This is why 47% collect welfare for some kind. This is why 27% of the country is on food stamps. This is why as a recent analysis of New York state records show massive cashing of food stamps in liquor stores, strip clubs, casinos, and electronics stores.
The Marxists, err democrats will always vote to take away from the working guy. Check your most recent paycheck. Let me know if it was smaller than your last one...
Perhaps shutting down the govt would be a great thing. It just might let some people know we have spent too much and change some voting patterns, particularly those who vote in blocks for big govt and big spending.
Naw. Too many people are just plain stupid and stubborn. Those people will not learn, even when they suffer, they will blame the same people they have been blaming all along.
There is no "Next Crisis", it is the same crisis it has been, OVERSPENDING. Without overspending we wouldn't have the problems we are continuously faced with. If Obama won't implement changes that would bring jobs back at 300 to 400K jobs a month, then spending needs to be cut, and the pretend things are getting better policies need to stop.
Obama will just raise it again and then blow money past the limit and ask for a higher limit at the end of the year.
Government's rule is to get a credit limit then overspend and blame it on others. A balanced budget or not spending more than you have is alien to all politicians because there are no repercussions from the sheeople.
This bickering over raising the debt ceiling is a joke. It's nothing more than smoke and mirrors, to keep the people dumbed down.
We operate under the federal reserve's fractional reserve debt monetary system. All M1 money, (The only money that we the people, businesses and government are allowed to use to pay our everyday operating expenses), can only be created through the (extension of credit from private commercial banks, or in the case of government borrowing, through treasury bills, notes or bonds).
All money is debt before it enters into circulation. The worst part is that there is no money created to pay the interest on the principal created, so we are always creating a debt greater than the debt money supply.
This system must eventually fail. There will come a time when people will have to choose between paying their taxes or feeding their families. When that time comes. the government will not be able to honor it's thousands of contracts with businesses, and the stock markets will fall. What's invested in those markets? Your IRA's, 401K's and pension plans.
There is a way out of this mess, but congress doesn't have the guts to go against the fed and it's bankers, who donate to their reelection campaigns.
Give back the power of creating money to the treasury, and let them pay for maintaining old and building new infrastructure. Notice I said pay for, (Not borrow). This would create millions of livable wage jobs, with full benefits, taking people off of the unemployment and welfare roles.
While the treasury would be busy creating new wealth money, we could put gradually increasing reserve requirements on the federal reserve's system, until the new wealth money was strong enough to take over and eliminate the fed and it's debt system!
what have we got to lose? We are heading for disaster as it is. Why not try something that has a chance at success?
There would be no need for road use or fuel taxes. We could build mass transit systems for every major metropolis in the country, without borrowing. We could do a proper job on preparing for natural disasters, like hurricanes and floods. All money created would be matched by productivity, and we wouldn't be placing debt on the backs of our children and grandchildren.
Just look back into history. Ever since we allowed the federal reserve to take over, or indebtedness has increased. Only a small percentage of the population reaps the wealth, while the rest are actually financial slaves to this debt system. Think about the loan process. Banks create money out of thin air, on your promise to pay it back, when you sign that loan agreement. Then they collect interest on loaning something that they never had in the first place! Remember, no money is ever created to pay the interest on the loans. That has to go into the cost of doing business, and continually raises the cost of living. This system forces us to borrow in order to have a medium of exchange. It also thrives on the military/industrial complex to keep it going. That's why so many wars are fought, to keep this ponzi system alive.
As a former small contractor which did some work for the DOD, I found the actual waste was horendous. I literally witnessed a contract that would remodel a building and within a couple of years the building would be demolished. This goes on all the time. What I've also witnessed as observations at all levels of government the only way to limit waste is firm cuts to budgets. This leads me to conclude that a 25% cut is possible without touching any benefit, it would merely make those responsible "more responsible" limiting waste and corruption. Niether Republicrats nor Demlowcrats will have the will to "slash and burn" but instead will tell everyone they are cutting, but instead afterwards we will find out that in fact spending will continue unabated. Kinda like the "tax cliff" arrangement, now everyone is realizing the Obamlacrats and Repubicrats kept the details secret. Our nation cannot be saved, the "trough feeders" have a voracious monetary appetite for greed and plenty.
We have an ever growing portion of our population for whom there will never be a living wage job unless fundamental changes are made. Automation and job export have hastened the process. Add to that an aging slug of baby boomers that will soon go on benefits and it boggles the mind how we can ever get through this. Politicians can be quite intelligent when taken singly but collectively they are idiots. I feel like used car salesmen are running this country. (no offense to you used car salesmen) We have been suffering from a short term mentality for too long.
We have been losing the trade war for 30 years but we keep on playing the game. We handed our industrial balls over to foreign countries where their governments manage commerce like military campaigns and we wonder why we are losing? How's that trade deficit with China going? They sell us everything we used to make and we sell them KFC. That was a great deal wasn't it.
Slavery was a terrible thing when it was happening within our borders but we seem to have no problem with it when it is occurring in some third world country. And just like the slave owners in the 18 and 19th century, people (now corporations) are getting rich from it. Problem is, there are fewer and fewer people that can buy anything these days so the system is collapsing. Since corporations aren't hiring, the government has had to step in and support the masses that used to work for a living. Take away that support and you are back to the soup lines of the 30s. Short of some great pandemic or nuclear war, we are going to have a lot more people than jobs for the forseeable future. That's what we need to address and we are already too late.
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