With the government shutdown averted, pretty much as
expected, with only a short term “truce”, it looks like the “war” in Washington
DC is likely to continue for a very long time.
Even if Republicans win the Senate in 2014 by gaining several seats, no
faction will have the 60-75% majority needed to make major changes. Gridlock and continued “drama” is likely
until the next Presidential election in 2016. (Elections do have consequences!)
Everybody knows that deficits and our long term debt
levels, along with ZIRP (Zero Interest Rate Policy) and QE (Quantitative
Easing) by the Fed are not sustainable in the long run. So far, because of
unemployment and a slow growth economy allowing low interest rates, deficits
and debt have been easy to bear. The question is: How long will this last? And, what comes next?
This link will take you to the governments records of
revenue, spending and deficits since 1930. http://www.whitehouse.gov/omb/budget/historicals It is a
remarkable picture and provides little hope that deficits will ever end. It simply appears that the American system of
government does not encourage a balanced budget. Also, there are way too many so called Economists
who foolishly argue that Federal Debt as a % of GDP is the only thing that matters—not the
total debt per see. Hence, it is likely that the debt will continue to grow. You
should know that the White House now predicts that the debt will “level off” at
around an enormous 105% of GDP.
Now to put that into perspective, some think that
would be like a family with $100,000 of annual income maintaining a debt level
of $105,000. So if that family was able to increase their income by 3% to
$103,000, using the “maintain the debt level” concept, they would increase
their debt by $3,000—spending $3,000 more than their income. But
wait! GDP is the income of the entire
economy and debt is only the Federal Government’s. If government income is now 20% of GDP, then
the National Debt is really 525% of the Federal Government’s income. So in reality, it’s more like a family with
$100,000 of annual income having a debt of $525,000. Using the argument
that it is only important to maintain debt as a % of GDP, that 3% increase in
debt caused by the $3,000 “deficit” goes entirely to the Federal Government
that would then have an a spending rate of 22% of GDP. This is the argument put
forth by some Democrats including Austan Goolsbee, former Chief Economist for the Obama
Administration--he regularly reinforces this with appearances on CNBC. Republicans argue that the Federal Government’s
share of GDP should remain the same 20%, meaning that over time the debt as a %
of GDP actually decreases. The “deficit” in this example would be no more than
$600=20% of the GDP increase. And debt as a % of GDP would go down to 102.5% in
the one year of the example given here—decreasing each year over time.
This is really what the struggle regarding the debt
ceiling was and is all about. No matter what the media says about polls
regarding approval ratings and public opinion, those that just want to “get
along and go along” are really not doing the country any service. Democrats
want the Federal Budget to go up and are comfortable with a lot of debt. They
are convinced that higher taxes will solve the problem. Moderate/Traditional Republicans, even those who call themselves "Fiscally Conservative"
are OK with the Federal Budget and Debt rising albeit at a slightly slower
rate. They are against higher taxes. Conservatives are demanding that the Federal
Budget be restrained with spending AND taxes at somewhere around 18-20% of GDP--This
would actually result in taxes slightly higher than they are today. The present
stalemate with big deficits and rapidly rising debt is a very serious threat to
our future prosperity. The argument supporting high debt levels (100% of GDP)
is like the assumption made by borrowers and lenders that led to the 2008
Financial Crisis—that nothing bad would happen unexpectedly and that incomes
would rise steadily. (The assumption that a person with $100,000 income could
carry a $525,000 mortgage----Certainly possible as long as they don’t lose
their job or get sick and as long as their income rises over time---and as long as interest rates don't rise too much.)
As an investor, you should hope that the Conservatives
continue to argue their position as they at least restrain the other groups to
some degree. History teaches that US prosperity requires a Federal Debt as a %
of GDP in the range of 30-60%--a substantial reduction from present levels. Failure to move in this direction will surely
lead to slower economic growth due to inflation, substantially increased taxes,
or both. Since it is unlikely that this substantial reduction in debt will
occur before 2016, it seems wise to prepare your investment portfolio for a
slow growth economy with both rising inflation and rising taxes expected--sooner or later. This
calls for a conservative strategy of owning a portfolio of high quality stocks—highly
diversified by industry and geography, but with a focus on profitable companies
that increase their dividends regularly.
We have been focused on risk of recession with
resulting deflation for several years. I humbly submit that the risk of slow
growth with inflation and rising interest rates along with much higher taxes is
the most likely future scenario to prepare for at this time. (Think 1970’s and
Jimmy Carter--sort of.)
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