11/16/2011 6:37 PM ET|
Will DC wreck the economy again?
We've seen politicians in Europe roil the market, and now the congressional supercommittee is running out of time. Will members make the hard decisions we need?
As the kids were gearing up for Halloween just a few weeks ago, everything seemed right in the financial world -- or at least, back on the right track.
Europe had hammered out an against-the-odds agreement to save Greece and bolster its bailout fund. The U.S. economy was revving up again with a solid third-quarter report on the gross domestic product. And central banks around the world were opening the floodgates, washing the financial markets in more cheap cash.
Then it all went wrong. It went wrong because of politicians. It went wrong because of democracy. And it's about to go wrong again if the bipartisan "supercommittee" in Congress fails to agree on at least $1.2 trillion in budget savings over the next 10 years through tax hikes and cuts to popular programs like Medicare and defense spending.
The committee's deadline is Nov. 23 -- a week from now. And hopes are not running high.
It's worth remembering that the economy looked ready to rev up in late June and early July, before the debt and deficit mess in Washington in August. And it looks like the politicians are ready to derail the nascent recovery. Again.
The European example
To put all the political wrangling in context, let's start in Europe.
On Oct. 31, then-Prime Minister George Papandreou of Greece, frustrated by a lack of political support and violent popular protests, shocked the world by announcing he would put the latest bailout plan -- the so-called "Oct. 26 agreement" -- to a binding vote by his people. The measure likely would have failed, in an act of democracy the financial world clearly feared.
Papandreou has since left office, and the shock waves of this move have reverberated through the world economy.
The European bond market has come under fresh attacks, pushing Italian bond yields to unsustainable levels -- a much more serious economic threat than Greece represents. Spanish, Belgian, Austrian and even French borrowing costs over German equivalents have also climbed as doubts grow over the financial health of all these countries. The eurozone's bailout fund, the vehicle that's supposed to put an end to the crisis once and for all, is having trouble raising cash. What was once unspeakable -- the removal of countries like Greece from the European Monetary Union -- is now being discussed in Berlin and Paris.
All this uncertainty and volatility comes with the eurozone rapidly falling into a deep, new recession. Eurozone industrial production dropped 2% in September from August. Worst hit was the capital goods sector. The latest eurozone purchasing managers survey points to a "sharp contraction" in economic output in the current quarter according to Capital Economics.
Recession will only worsen the debt crisis by deepening the deficits of Greece, Italy and others. America could meet a similar fate unless it acts swiftly to enact short-term stimulus and sensible medium-term measures to close the deficit focused, mainly, on out-of-control health care costs.
Politically impossible bills to pay
The reason the fallout was so swift and so severe is that Papandreou's gambit struck right at the point of weakness for the rich world's post-bubble economic reality: After years of living well off of cheap credit, the bill has come due in the form of harsh austerity -- something that's politically unpalatable.
Elected officials, who promised voters the world during the boom times, don't have the guts to do what's necessary now, in a time of tepid, post-crisis growth. Popular protests and fringe political movements, from deadly clashes in Athens to Spain's indignados and the rise of nationalist, euro-skeptic parties in places like Finland and Slovakia, only make it worse.
This is why the governments of both Greece and Italy have been replaced with unelected technocrats tasked with implementing painful spending cuts and tax increases before new elections are held. Free of the demands of democracy, these new leaders can do what elected leaders would not.
And they need to do it quickly. Unless Greece can secure its next batch of European Union/International Monetary Fund bailout cash, it will be bankrupt in a matter of weeks. In Italy, borrowing costs are on the same trajectory that doomed Greece, Ireland and Portugal. And now, the focus of the market's fury is shifting to other "core Europe" countries like Spain and France.
Back in the USA
Similar dynamics are playing out here at home as Democrats and Republicans knock skulls over taxes, spending and the deficit. Their constituents scream for jobs, while groups like Occupy Wall Street, Grover Norquist's Americans for Tax Reform and the Tea Party press hard for competing demands.
The unwillingness to make politically risky choices is why, back in August, when the deal to raise the debt ceiling fell short of what was needed to stabilize the fiscal outlook, Standard & Poor's cut America's AAA credit rating. The market hasn't recovered from that downgrade.
Congress committed to budget savings of less than $1 trillion over 10 years, with an additional $1.2 trillion hopefully coming from the select supercommittee. S&P was looking for something closer to $4 trillion in savings to keep the U.S. rated AAA. The analysts added that the government was losing its ability to manage public finances, due to "America's governance and policymaking becoming less stable, less effective and less predictable." This interparty bickering, which took the country to the verge of a government shutdown and default on its debt, "weakens the government's ability to manage public finances," they suggested.
America faces stark choices, tight deadlines and scary consequences for inaction, too. Yet politicians continue to dance around the inevitable, unable to compromise and unwilling to do the honorable thing: sacrifice their political careers to do what's right for the country.
The US debt picture
Even assuming the supercommittee gets a deal proposed in time for Thanksgiving and it gets passed by Congress for Christmas, America's debt will continue to grow. Analysts at S&P expect that, assuming the Bush tax cuts are extended for the majority of Americans (a stimulus measure that enjoys a modicum of bipartisan support), net government debt would rise from 74% of GDP this year to 85% by 2021. So more spending cuts and higher taxes will still be needed.
But if Congress fails to act, the $1.2 trillion in automatic cuts kick in (hitting defense spending hard), the economy will weaken in the face of Europe's tailspin, S&P would likely cut the U.S. credit rating again (to AA from AA+) as the net debt load swells to 101% of GDP by 2021 and the government reinforces the notion that the country is ungovernable.
That, no doubt, would result in a harrowing repeat of the early August market collapse. A drop in financial wealth, and lost confidence, would push the fragile U.S. economy down into recession with the eurozone. China and the other emerging-market economies couldn't maintain their growth with the world's two largest economies in the ditch.
With a week to go to the Nov. 23 deadline, things aren't looking good.
Republicans have proposed a $1.2 trillion deal (the bare minimum) made up of $750 billion in spending cuts and $300 billion in new taxes, which come from lowering overall rates but capping deductions and tax credits.
Democrats have rejected this, arguing it would increase the burden on middle-class families. They've put forward a $2 trillion deal with equal shares of cuts and taxes. Republicans claim Democrats are resisting cuts to Medicare -- a shame, because medical spending is the main driver of the long-term budget mess.
News reports are filled with rumors that members of Congress are laying the groundwork for failure as the two parties remain far apart on taxes, Medicare and Social Security. There are efforts to save the Pentagon from the deep automatic cuts that would kick in if no deal is reached. There is also chatter that tough decisions on taxes, including the Bush tax cuts, could be pushed back until after the 2012 presidential election.
In other words, they're trying to kick the can down the road again.
Held in low regard
While our leaders won't face international pressure to abdicate, as we saw in Italy and Greece, the U.S. electorate isn't impressed; it gives Congress a record-low approval rating of 13% right now, according to Gallup. Nor are the Chinese: The Dagong rating agency said this week that it may downgrade the U.S. credit rating again (it cut our rating back in August) on a failure of elected leaders to deal with the deficit. Wall Street isn't impressed, either.
A deadlock in Congress now, one that likely wouldn't be broken until after the 2012 election as divisions harden, would result in a cascade of failures that will continue to pummel stocks, confidence and the economy. Merrill Lynch/Bank of America economist Ethan Harris expects at least one U.S. credit rating downgrade in late November or early December as a result of a failure by the supercommittee to create a "credible" deficit-fighting plan.
Even if the bare minimum $1.2 trillion deal gets passed -- likely with accounting gimmicks such as overly optimistic economic growth projections -- a number of other major decisions loom over the next year that will require hard-to-come-by bipartisan support. These include expirations of the $90 billion payroll tax cut, $40 billion in extended unemployment benefits, tax incentives for business investment and the Bush tax cuts, as well as another decision on the U.S. Treasury's debt ceiling.
In the months to come, if the two parties battle as the economy burns, the solution embraced in Italy and Greece-- unelected technocrats -- may look more and more attractive as the deus ex machina to get us out of this mess.
Greek philosopher Plato warned of this more than 2,400 years ago in ancient Athens, claiming that the absolute freedom of democracy and the freedom of speech and license to do as one wishes can devolve into an unmanageable state. He compares such a place to a dilettante with no discipline; a hedonist with neither order nor necessity nor an appetite for sacrifice and self-control.
The country, drunk on the insatiable desire to have no master in any facet of life, becomes intolerant of any whiff of elitism, fiscal responsibility or denial of any earthly desire. Leaders aren't allowed to place the least bit of austerity on their people. To stay in power, they must be pliable and provide plenty of what the people want -- namely, low taxes and lots of government spending.
Otherwise, they are punished. Think about that when the 2012 elections roll around.
More immediately, on the investing front: I've been advising trade-minded subscribers to my newsletter on ways to try to catch the market's ups and down for the last few months -- ups and downs that are set to continue, and require quick action to try to play.
For average investors, it's much tougher, because the market is moving based on politics and macroeconomics rather than anything a particular company does. There are also few attractive alternatives. Treasury yields are in negative territory and are likely to underperform over the long haul. So for now, hang on.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at firstname.lastname@example.org and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
VIDEO ON MSN MONEY
Will Washington D.C. wreck the economy again?
Is the Pope Catholic? Are politicians engaged in insider trading?
Lets start with pay cuts for congress and the president, all of them , not just the active ones, but the retired ones too!
Stop wasting money on "the war on drugs", it's not working! Drug use has to be eliminated on the demand side, not the supply side. There will always be a supply as long as there is a demand for it. You can't stop it. Focus on prevention ,education ,and rehab!!!
Cut other wasteful grants to the rich and spending on "rich man's follies".
Stop acting as the world's police. It's not our job, and we do not have the right to tell other nations how to live.
This country will not be righted until we remove ALL of the current politicians and we start from scratch again. Our "trusted servants" have been bought and paid for by private interests.
It is treasonous that a congressman or senator would sign a pledge to ANYTHING OTHER THAN THE UNITED STATES OF AMERICA.
How could we let them proudly tout that they signed a pledge to Grover Norquist?!?!?!
Seems like there is a conflict of interest to me. NO politician to go into office that way. It should be the American People's interest they are there to serve, no matter what. If it's best for the country to raise taxes, then so be it. If it's for the best of the country to lower taxes, then so be it. The issue should dictate the resolution, not some treasonous pledge to Grover Norquist.
Simply stated, the problem is: Too many politicians making too many promises, and spending too much money that they don't have.....with no way to pay it back.
That's the European problem in a nutshell. And the American problem as well.
I especially loved the line in the story about austerity being "politically unpalatable". Translation: The politicians are more concerned about saving their jobs than solving the problem.
When you spend over 800 billion dollars perpetuating a lie it does the economy no good.The wars in Iraq and Afghanistan are the major causes of our debts. that and run amok spending by Congress and their entitlements. We had no reason to go into Iraq and Afghanistan other than the idiots in Congress were duped by Bush and his band of idiots. We spend/handout billions to foreign countries to help with their infrastructure, education and socila programs while here at home we have returning verteran unemployment at 12%. We have people living on the streets, our roads and bridges are crumbling, our education system is worse than that of some third world countries. I say "AMERICA FIRST"!!!! We need to stop being the worlds policeman, we need to stop being the social conscience of the world. When we have every citizen here fed, EMPLOYED, housed and all our needs met here for our country and people then maybe we might look at helping the rest of the world. Until we reach that point we need not to hand out money to help out foreign countries. And if Congress cannot do the wishes of the people then they need to be replaced. We hired them, WE CAN FIRE THEM! But the American people`s needs must come first before some foreign country plain and simple. I myself don`t care what the rest of the world thinks about us. Do you?? I served my country in the military and have seen some of this. It is time for a change!!
Until this administration understands the following, nothing will change. It will only continue to deteriorate.
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, takes first 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 worked for, that is the beginning of the end of any nation.
This scenario is being played out in Greece, Italy, Spain and France. If we don't get our own house in order quickly it will soon becoming to a theater near you.
Vote the bums out in 2012!!!!
I am willing to accept a cut in my Medicare when Washington eliminates their pension plan and increases their benefits contribution to at least 40% of the premium we taxpayers are stuck with!!
That will never happen because of their greed! They believe they are entitled to as much of our hard earned wages as they want!
Rigs1950....good points...I totally agree that an uneducated electorate put us in the mess we are in voting on promises made by lying politicians.
The politicians in DC have not just wrecked the economy, they have wrecked this country and we the people better wake up and stop what is going on before it is too late.
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