…..is a kept one. And with that in mind, we turn our attention to last week’s presidential debate in Denver. We shall leave the sifting through the minutiae to the fact checkers and only point out that both candidates, while not necessarily venturing into the territory of whoppers, certainly tested the malleability of budgetary math. Lost in the punching, counterpunching and subsequent spin put forth by each campaign, is the fact that two very different visions of the role of government in the U.S. economy were on display. Chiefly how the government can aid the economy’s return to trend-line growth and how to best get the federal government’s fiscal house in order. These larger points are the ones relevant to the mission of these pages, which is to identity how policy choices impact both the outlook for financial markets as well as that of John Q. Public as he continues on his quest for steady employment, a mortgage that does not require a snorkel, and after years of stagnation, real wage growth. In short, which of the two gents on the stage in Denver would be less likely to blow up the economy once again.
Lies, Damn Lies and Statistics
These divergent guiding philosophies were especially, if not accidently, on display as the candidates made claims on three subjects that have come under heavy scrutiny ex post facto. Governor Romney was put on the spot by the assertion that he wants to cut taxes by $5 trillion. A loss of revenue by that amount would greatly exacerbate the federal deficit. The governor pointed out that all cuts in tax rates would be offset by the closing of loopholes and deductions, thus making it revenue neutral. In theory that sounds great - broaden the tax base. But the governor did not help his cause as he failed to name which goodies he would axe. Existing loopholes and deductions did not accidently find their way onto the books. Each one represents the interest of an industry or group that likely has plush K Street offices and key committee members’ numbers plugged into their iPhones. In other words, they’ll fight tooth and nail to maintain their existing tax treatment. Similarly, he did not state how much incremental growth lower tax rates would produce, which in turn would (theoretically) increase government revenues as business activity and incomes rose. Without such specifics, Romney has exposed himself to the accusation that this tax plan is not revenue neutral and thus would aggravate the deficit.
President Obama caught grief during and after the debate with regard to the claim that his plan would reduce the deficit by $4 trillion (compared to what it would have been) over the next four years. He, like Mr. Romney, was criticized for a dearth of details, but also had to deal with the accusation that most experts have dismissed his claim as accounting “gimmickry.” Additionally, and with no disrespect intended, the President has a record, one that shows he has few misgivings about running trillion dollar deficits in order to fund his vision of a larger, more pervasive government.
Both candidates have taken heat for the numbers surrounding their Medicare proposals. Democrats decry the Romney/Ryan plan as one that hacks over $700 billion from the program. But such a cut is only a cut by Washington’s upside-down standards. In the Beltway’s universe, an increase in expenses at a slower rate over a specific budgetary time horizon than originally proposed is a cut. So yes, Margaret, in this world, 2+2 does equal minus-2 if the original equation was 2+4. Coincidently, the Obama plan purportedly cuts a similar amount from Medicare. However, Republicans state this this is a real cut rather than a decrease in the rate of expense growth. Worse, the savings are funneled to their arch-bugaboo, Obamacare, to mask the deteriorative budgetary impact of that program. Although denied in several quarters, analysis by the Heritage Foundation (hardly a nonpartisan outfit, mind you) using Congressional Budget Office (CBO) data, concluded that this is indeed the case.
The $1.3 Trillion Elephant in the Room
Discussion of these issues supposedly highlights the candidates’ genuine concern with deficit reduction. Really? Sorry to tell the Governor, but there are likely not enough tax loopholes to close to make up for his proposed tax cuts. And as for the President, there are not enough millionaires, billionaires, corporate jet-owners and slick Wall-Street types (often millionaire corporate jet owners….so he’s double counting) to pay for his expansion of government programs let alone deficit drawdowns. As important as the deficit is….and to the Tea Party faction it is the holiest of holies….are we to believe that either of these candidates, or any politician for that matter, during the height of an election season will tell voters that they have got to suffer even more to right the country’s fiscal wrongs? Just ask the recently collapsed governments of Greece, Spain and Italy how well that went over. This message is never an easy sell, especially when voters are consumed with matters such as kick-starting substandard economic growth and reducing sticky joblessness.
The need to once again attempt to goose the economy while the country is already running massive deficits puts policy makers in a bind. It is not as easy as studying what steps Japan took during its lost decade and then doing the exact opposite….although that may not be a bad strategy. In an interview last year, former Fed Chairman Alan Greenspan cited several central bank studies which concluded that between the two stimulative paths of tax relief and increasing government investment, both add to the deficit, but the former adds to it less. Taking a knife to the deficit in a catatonic economic environment is borderline implausible. By definition, in an economic slowdown, tax receipts fall while government expenses, in the form of automatic stabilizers (e.g. unemployment insurance and the oft-cited rise in food stamp recipients) kick in. A politician can…and likely should…..question the policies that have led to such demand for these services, but to rip them away when the so many people are out of work, underemployed, digging out of debt and getting indirectly taxed by having gasoline prices at just south of four bucks a gallon would not only not win him/her any popularity contests, but also but tamp the brakes on already tepid consumer spending.
To hear the candidates fawn over the conclusions of the oft-referenced Bowles Simpson report one would think it would be a no-brainer to implement its recommendations. But for reasons mentioned, it is unlikely for politicians to take the suggested steps such as closing tax loopholes, slashing discretionary spending, reducing the growth of government healthcare expenditure and capping government’s slice of GDP to 21%.
After dodging these tough decisions, Washington placed the economy on a path to careen over the so-called fiscal cliff, a mix of austerity measures so draconian that a viable alternative would have to be reached. Behaving not quite like adults, officials chose to punt. Most economists agree that should the components of the fiscal cliff be enacted, the U.S. will dip back into recession in early 2013. In the table below the CBO projects what the impact would be on the economy should we zoom into the abyss. Knowing Washington well, it also estimates what would occur should an alternative path be taken. This scenario is based upon the assumption that current tax cuts will be extended… denying purported deficit hawks of additional revenue….while refusing to make any substantive cuts in expenditure. You know, business as usual, or put another way: cowardice.
An Investor’s Take
Despite chronic gridlock and/or government mismanagement, businesses tend to find a way to survive and even thrive. This time may be different. The economy is stuck in low gear and government should adopt policies to promote growth. At the same time, the U.S. can no longer avoid its fiscal irresponsibility, especially with Europe providing a real-time good bad example. Major decisions regarding the debt will need to be made and the government must identify ways in which it can help the economy grow, a charge in which it has fallen woefully short. Managers and investors like clarity and until these two issues are sorted out, they will likely get neither.
Over the long-term, investor interests are aligned with those of the consumer. This is especially true in an economy in which consumption comprises 70% of the pie. Productivity growth benefits both groups. Regulations that impede bank lending, job creation and business investment keep a lid on consumption growth. Milton Friedman argued that short-term incentives such as tax rebates and other government transfers do not impact spending patterns. Consumers are smarter than that and instead adjust spending according to long-term earnings prospects, something best delivered via a pro-growth agenda. That said, given the number of people presently receiving some form of government support, an immediate pull-back of such programs in the name of austerity would likely add yet another headwind to consumption growth.
Eventually a fiscal adjustment must be initiated and that’s when blood hits the streets, especially as a growing number of Americans come to depend upon Big Brother….I mean Uncle Sam….for a variety of services. The temptation of authorities to monetize external debt by debasing the dollar would hit consumers with a round of imported inflation as well as slash valuations of USD-denominated financial assets. Some hope that policy makers will react to the concept of a discipline of debt, meaning when servicing liabilities gets stretched to the limit and additional credit-rating downgrades appear likely, they will make the tough decisions. Didn’t we just try that in advance of the fiscal cliff? In the end, current policy makers have themselves to blame as policies enacted over the past several years managed to neither enable economic growth to reach escape velocity nor address the fiscal imbalances that have been years in the making.