Historically high levels of debt in the US and elsewhere are high on the list of economic challenges. To the average investor it seems like an open-and-shut case. The political environment accentuates this tendency, as leaders of all stripes blame others for poor taxing or spending policies.
The successful investor needs to take a deeper look, since there are many facets to this question. I have written a number of articles related to the US budget deficit, which I feel is treated with undue doom and gloom by the financial blogosphere.
“Here at ‘A Dash’ we have emphasized a certain type of dilemma for policymakers. One side of the issue has a position that seems obvious. It is easy to explain in terms that resonate with the average voter. The other side is more complicated. It might involve some abstract modeling. It might require economic analysis. The consequences of the decision might not be readily visible and traceable to those affected.
Budget deficits are like that.”
The oversimplification of the issue (November 7, 2007) itself is the main thing that I believe impedes the investor from grasping a firm understanding of the US deficit.
“China is not on the verge of calling in all U.S. loans. Many try to understand international economics through a gross oversimplification: thinking of countries as individuals or families. In fact, Chinese leaders maintain a trade imbalance because it helps them grow their economy and employ workers. It would not be in their self-interest to weaken their own industry or the value of their current dollar holdings. Despite these facts, pundits have created a climate where many expect imminent disaster from this debt.”
I draw upon my academic experience in the post Deficit Perspectives (February 18, 2010), in which I criticize the irrational attitudes parroted by pundits and financial bloggers.
“Most people come to a discussion of debt and budget deficits with their minds made up. People love to take their own experience and use it as a model for how organizations do and should make decisions. It is the starting point for a beginning social science student. The key is to learn why organizations do not behave like the individual members.”
As I often say, carefully monitoring economic debate helps keep the individual investor ahead of the curve. Since the deficit is one of the most hotly debated issues today, I covered a recent exchange on the subject (June 10, 2010) from CNBC.
“In the Laffer/Altucher matchup, one of the participants has a napkin and the other provides a quiet review of data -- earnings, interest rates, and other factors that are different from 1981. If you watch this as a debate, and I urge you to do so, it is pretty one-sided.“
As for how the deficit impacts the individual investor, I have my own realistic advice (March 30, 2010) to offer:
“If you are going to wait for a widely accepted solution to the deficit problem, you are a PermaBear!
We have faced federal budget deficits for decades. The Clinton Administration was the only surplus producer in recent times. This problem will eventually be addressed. As an investor, if you wait for the official solution, you will be far too late. The key problem is that most observers want to "solve" the deficit question while we are still in the middle of an economic crisis. Savvy public policy analysts take a different view.”
Near the end of 2012, I took to settling down much of the hype surrounding the so-called Fiscal Cliff. On September 11, 2012 I pointed to the threat from Moody's to downgrade the US Credit Rating if significant steps weren't taken to address this issue.
"'If those negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable,' Moody’s said in a statement. 'If those negotiations fail to produce such policies, however, Moody’s would expect to lower the rating, probably to Aa1.'"
While actions from these unelectable and unaccountable credit agencies weren't particularly helpful, I encouraged investors to focus on the most likely policy outcome.
"My current conclusions are threefold:
- Immediate concerns exaggerate the negative outcomes, mostly because traders and pundits are excessively negative about government, politicians, and political processes;
- The worst case is well-known, and well-publicized;
- There is no immediate upside catalyst.
Those who seek a great, long-term entry position in stocks have it right now (as I explained here). I predicted that prices would become even more attractive (e.g. move lower) if the economic concerns escalate.
I was pretty aggressive for new accounts at their prices as of the final quarter in 2012. I warned that those who wait for a complete resolution to the Fiscal Cliff will have higher prices, less risk, and less reward.
My advice was to ignore the MSM cacophony of fear about the fiscal cliff. We can re-evalute after the election."
On November 11, I made an attempt to put things into a clear context for the individual investor.
"I can state this pretty simply: A dive over the fiscal cliff will not happen. There are specific and personal tax and budget consequences for nearly everyone -- especially major GOP constituencies like those who will get hit with the Alternative Minimum Tax and business leaders who need to plan. Most people seem not to realize how close the two parties are to a reasonable compromise. I first expect a temporary plan that will address some problems and buy time, but I would not be surprised to see specifics sooner than most expect.
Meanwhile, what we had at that time was only a little bit of preliminary posturing. I asked readers to imagine that they were about to represent your team of investors (or workers or business leaders) in important negotiations. Would you start the process with a public declaration of your best and final offer?
There is no information in this posturing, but I predicted the media would prove to be a sounding board for all sorts of wild statements. These provided a negotiating position and set the stage for compromise. Meanwhile, the stock market rallied on one sentence from the President or the Speaker, and then sells off on the next. Most of the predictions came from those who no experience or track record in forecasting public policy outcomes. They also seem to have forgotten that the election is over, providing a window of opportunity for joint action before the battle resumes."
On November 18, I was able to further clarify precisely what issues would be at stake for the individual investor regarding the fiscal cliff.
- A resolution to tax issues that will cover at least the entire calendar year of 2013. This will include the Alternative Minimum Tax, the "doc fix" for Medicare adjustments, and the extension of Bush-era tax cuts.
- Despite the more extreme comments, everything is on the table. The revenue package will include more from the very rich, but the dividing lines and rates could be something you have not even heard yet. I expect capital gains and dividend taxes to peak at 20-25%
- Some of the longer-term changes in spending and entitlements may get very hard targets right now, with the opportunity for the new Congress to fill in the details.
- This could all happen very quickly. It is NOT like last year. There are specific consequences for individual taxpayers, not just a general principle like the debt ceiling or a recession. Congress also wants to adjourn before Christmas.
At the end of the day, my predictions regarding the Fiscal Cliff were spot on. While we technically went "over" the cliff, lawmakers made the necessary compromises prior to any tangible sequestering or tax increases taking place. The debt ceiling fight still looms, and our nation's fiscal crisis is still very serious - but at the very least all this Fiscal Cliff business has finally been put to rest.