10/24/2012 8:00 PM ET|
How we can avoid the fiscal cliff
The bite of austerity
Economic experts have long debated just how austerity via tax hikes and spending cuts would affect an economy. For a while, many, especially in Europe and in the far-right wing of the Republican Party in the United States, believed that budget cuts could actually spur growth by boosting confidence. The discussion focused on what's called the "fiscal multiplier," a measure of the severity of the real impact of those tax hikes and spending cuts.
Clearly, the fantasy of expansionary austerity has been proved wrong by what's happening in Europe and the U.K. So the multiplier is a positive number, meaning tax hikes and spending cuts actually hurt growth.
Here's the thing: The IMF and others believed the multiplier was around 0.50 or so, meaning that a 1% tax hike would result in a 0.5% drag on GDP growth.
That appears to be wrong, too. Given the current economic situation of low growth, excess capacity, long-term unemployment, ultralow interest rates and over-indebtedness, the current multipliers are believed to be higher -- much higher.
In its latest economic outlook, the IMF's chief economist laid out the case that the multiplier could be as high as 1.7. So that 1% tax hike would result in a 1.7% drag on growth. And given what we've seen in Greece, the U.K. and Spain, larger multipliers seem more likely. This is backed up by research from other economists all saying the same thing: Multipliers seem to be higher than 1.
So you see, even if Washington finds a middling solution, such as any of the three scenarios Merrill Lynch outlines in the table on the previous page, the impact will still be powerfully negative. It would be a game of pick your poison, depending on which of the three potential compromise deals Congress and the White House could reach.
But even then, the market could still react negatively to the drag on growth. Merrill Lynch's Priya Misra estimates that only about $40 billion to $80 billion of fiscal tightening is priced into the Treasury bond market, even as the Merrill Lynch team expects $300 billion or more in tightening.
Simply put, even if we assume Washington can hammer out a deal early enough to settle the stock market turmoil and avoid more credit downgrades, we're still looking at a drag on economic growth of between 2% and 3.4% of GDP next year.
Among the impacts: The unemployment rate wouldn't stay under 8% for long.
Yet denial isn't an option. If the fiscal cliff is ignored and all the tightening I've discussed avoided, the bipartisan Committee for a Responsible Federal Budget believes the nation's debt held by the public would grow by an additional $7.5 trillion through 2022 -- an increase of nearly 70% over the next 10 years. The negative impact of more and more sovereign debt is well documented in the academic literature. In plain English, it's hard to pay down debt -- and the deeper into debt you go, the harder it becomes, because your economy gets weaker and weaker.
The escape hatch
Now that the situation appears hopeless, let me try to talk you off the ledge. There is still a narrow window of escape from this mess. The broad outlines are:
- A pro-growth, revenue-neutral tax plan such as the one promised by Mitt Romney (and an idea that has attracted bipartisan support in that past) that boosts CEO and small business confidence and encourages a bounce-back in corporate spending, capital expenditures and hiring. This will help growth and will ease the pain of closing the deficit. This was the subject of a column I wrote two weeks ago.
- An end to one-time tax credits (research shows they are of marginal value) such as the temporary payroll tax cuts and temporary R&D credits. Or, if they're worthy, make them permanent.
- A solution to the true source of America's long-term, structural fiscal deficit: out-of-control health-care cost inflation and unfunded entitlements. As things stand, the Congressional Budget Office believes the cost of government health care spending will grow from 5.4% of GDP now to 12% by 2055.
I prefer the Republicans' market-based solutions, which rely on increased competition and promote price transparency, to the Democrats' government-based solutions. But something needs to be done, even if it's a European-style single-payer system that uses bureaucratic rationing instead of free-market price rationing. Our current system is broken and bankrupting the country.
Another quick note on health care: Before you say that the cost is worth it, given the quality of our care, that's just not true. Deutsche Bank notes that on a per-capita basis, America already puts "far more resources into health care than any other country, and gets less for it on a number of different standards."
You can see this in international comparisons on measures like deaths from medical errors and life expectancy, as well as the lack of correlation between the level of Medicare spending per beneficiary and quality of care across the 50 states.
And before people get upset at the term "entitlements," know that a typical middle-class couple retiring in 2010 is on track to collect $387,000 in Medicare benefits after paying in only $156,000 in taxes.
Meanwhile, back in your portfolio
So what are investors to do while the road to the cliff unfolds?
The dramatic breakdown of the major market averages this week, with the Dow Jones Industrial Average ($INDU) collapsing below key levels as money poured into safe havens like U.S. Treasury bonds, feels very similar to last August's meltdown.
I don't put a lot of faith in Washington to find a solution until confidence is shaken even further, stocks are plummeting and joblessness starts rising again.
So as an investor, now is the time to be getting defensive and raising cash. If you're more nimble, there are short-side opportunities in energy and foreign stocks, while on the long side, Treasury bonds are looking attractive (which seems counterintuitive since the Treasury has a fiscal problem, but that's just how things work).
My recent recommendations include the ProShares UltraShort Oil & Gas (DUG), ProShares UltraShort MSCI Brazil (BZQ) and Direxion Daily 20+ Year Treasury Bull 3x (TMF) exchange-traded funds. (You can see current positions in my Edge Letter Sample Portfolio.)
No one said breaking the addiction to cheap borrowing, easy spending and subsidized health care would be easy. But it's necessary.
At the time of publication, Anthony Mirhaydari did not own or control shares of any fund mentioned in this column in his personal portfolio. He has recommended the ProShares UltraShort Oil & Gas, ProShares UltraShort MSCI Brazil and Direxion Daily 20+ Year Treasury Bull 3x ETFs to his clients.
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The best way to step back is just to FIRE '57 States'. We don't need to raise taxes on anyone.
Oblama just needs more money to spend on his special interest groups. When W left we spent 2.95 trillion and took in 2.4 trillion. Now with all of the imbecile Obama's new spending we spend 3.8 trillion and take in 2.5 trillion. We have record tax revenues.
This idiot keeps trying to Tax, SPEND, Borrow and Print our way to prosperity. Obama is Arrogant, Lazy, CORRUPT and economically a clueless imbecile.
We need to FIRE Obama, slash government spending end the borrowing and PRINTING.
There can be no compromise on the TAX issue. WE NEED TO SLASH SPENDING 1.3 TRILLION FIRST. And as to fairness we need the deadbeat 47% to start PAYING taxes. 5% pay 65% of the taxes, 48% pay the other 35% and the 47% of deadbeat LEECHES pay NOTHING. Only dumb democrats can argue that UNEQUAL is FAIR. If that is the case we can have a lot of other unequal but fair policies. Wanna bet they are not for that idea?
So what is so wrong with allowing our income tax rates to revert to what they were when Bill Clinton was in office? If anyone has a short memory about those 8 years, our civilian economy was never stronger! My own educated guess is that higher income tax rates will encourage more productive investment at home trying to mitigate those tax rates. Why make it easier for wealthy Americans to invest offshore Anthony? Why not force them to invest at home instead?
As a member of the 80-90% group in annual income, along with a member of the top 5% in terms of net worth, I would be very happy to pay a little extra in taxes in order to enhance our national economic security in a manner beneficial to all Americans, and I would also be even happier if I knew that those above me on the totem pole were also paying their fair share to support their own country too.
Good article but the flippant reference that Medicare should be considered an entitlement because "a typical middle-class couple retiring in 2010 is on track to collect $387,000 in Medicare benefits after paying in only $156,000 in taxes. Give me a break! That couple started paying Medicare taxes over 40 years ago. If the government can't turn $156,000 into $387,000 over forty years, it's time to do something else.
Most religion's....Christianity in particular preach AGAINST DEBT> So what religious belief are you talking about?
Hey prgprops.....here's some inside information on how well government programs worked to get us ot of the depression:
"Treasury Secretary, Henry Morgenthau, angry at the Keynesian spenders, confided to his diary May 1939: “We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and now if I am wrong somebody else can have my job. I want to see this country prosper. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. I say after eight years of this administration, we have just as much unemployment as when we started. And enormous debt to boot.”
What I love best is that every cut to entitlements only affects the generations after the boomers. Funny that the boomers are the largest population block and any cut to them could have the greatest affect but no, their votes trump everything. Even though it was under their leadership that all these debts occured, and they got to see all of the benifit of them like lower cost education. In fact they got to enjoy unparrelled prosperity. Now they are screwing over their grandkids so that they, the most previlaged generation that did not have to ever make a single sacrifice, fight in any major war or endure any hardship and can retire in style. The arguement that they paid into it all their lives is BS because their kids and grand kids will also pay into it all their lives but get much less out of it so that the boomers can get every drop of their "entitlements".
I hope the polictians are lying when they say the current generation will not face any cuts, that is one promise I could enjoy seeing broken.
Entitlement = paying $156,000 in taxes and getting a single cent more in benefits 35 years later. You are not supposed to get a return on your investment. It doesn't work that way for people in your class (taxpayer class citizen). You should have been born in the investor class if you want to make a return on the money you put into something. With many businesses expecting a 3 year pay back on investments, I'm sure they would jump at the opportunity to invest $156,000 over a 35 to 47 year period to get a total of $387,000 benefit over the following 30 years. This even doesn't take into account the risk. No business would consider this a good investment even if you guaranteed that you would pay them the full amount in increasing increments over a 30 year period after they had to invest for so long. Investing the way that you have advised in the article over a 35 to 47 year time period should produce over $1,000,000 easily. I doubt that the weathly still remember why some of these "entitlement" programs and pro-worker laws like minimum wage were allowed to pass by the previous generations of wealthy people who controlled everything in their time like our wonderful rich people do today. When you allow most people to scrape by and feel like they are successful or at least believe that they have everything that they need, they are much less likely to commit crime focused at the wealthy who have cheated them out of the profit made by their labor. Combine that with blaming "colored people", "illegals", "feminists", "Communists", "Socialists", "welfare w_ores", "ungrateful unemployement dependents", etc for all the problems that poor people face and you can always be secure in your mansions. The poor fight blame and fight each other, while this "class warfare" is strongly discouraged by all media. It's not like the wealthy recieve more benefit than anyone else from common public services like roads, firefighters, and police. There is no reason for you to pay more than any working person. If I pay $15,000 in taxes total, then you should pay the same actual dollar amount even if you make $2,000,000. Of this wouldn't be fair if you earned the money by investing. If you invested to make the $2,000,000, you shouldn't have to pay tax on that because you truly earned the money from the hard work you did every day to get that. On the other hand, if you got paid $2,000,000 for a salary from an employer, maybe you should be taxed at a higher rate. That was someone else's money that you took when you got the salary, so you didn't earn it as much as the inverstor. Even better, your children are entitled to inherit all of your money tax free. Their hard work is what earned the money in the first place so they completely deserve the inheritance which is not at all like a hand-out.
Expiration of Fiscal cliff will not make any differance.Don't protect Rich and Corporations.
They only give part-time,minimum wage non leaveable earnings and no benefits.This part-tme
jobs to be counted as employment started during President Reagan, Republican Time.
Patriotic people should create more jobs and only wear U.S. Flag pin hippocratically.
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