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Ramifications of the 'debt deal' on long-term investing

If you have tears, prepare to shed them now…This was the most unkindest cut of all. — William Shakespeare (Julius Caesar)

Did the “debt ceiling” debate in Washington, D.C. between President Barack Obama, Speaker of the House of Representative John Boehner, and the Senate sour the American public on viewing democracy in action? And, are Americans going to be directly effected in the management of their personal and/or household debt, e.g. a home loan or car loan as a result of the “debt ceiling” politics? Answer: Yes, and yes.

Rasmussen polling agency reports sixty-one percent (61%) of Americans now think the national legislatures are doing a poor job. Most voters do not care much for the way either party performed during the federal debt ceiling debate. Further, Americans will be directly affected in the management of their personal debt. The majority of voters are worried that the final debt deal will raise taxes too much and will not cut spending enough. Only 11% of voters believe this Congress has passed any legislation that will significantly improve life in America.

August 2nd, President Barack Obama signed legislation designed to reduce the fiscal deficit by $2.1 trillion over 10 years. However, this was well short of the $4 trillion in savings that the S&P had called for as a good “down payment” on fixing America’s finances.

Back in mid-July, Standard & Poor’s had placed the U.S. credit rating on review for possible downgrade on concerns that Congress was not adequately addressing the government fiscal deficit of about $4 trillion this year, or about 9.0 percent of gross domestic product, one of the highest since World War II.

Downgraded Credit
Just days after the so-called ‘debt deal’ was signed, Walter Brandimarte (business writer for Reuters) stated that Standard & Poor’s cut the long-term United States credit rating by one notch to AA-plus on concerns about the government’s budget deficits and rising debt burden. Brandimarte noted that the move is likely to raise borrowing costs eventually for the American government, companies and consumers.

In a statement, Standard & Poor’s said, “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” Brandimarte noted that S&P’s decision follows a fierce political battle in Congress over cutting spending and raising taxes to reduce the government’s debt burden and allow its statutory borrowing limit to be raised.

It is clear that the political gridlock in Washington and the failure to seriously address U.S. long-term fiscal problems came against the backdrop of slowing U.S economic growth and led to the worse week in the United States stock market in two years. Economic pundits have stated that the U.S. downgrade could add up to 0.7 of a percentage point to U.S. Treasuries’ yields over time, increasing funding costs for public debt by some $100 billion, according to SIFMA, a United States securities industry trade group.

Brace for Local and Personal Spending Cuts
The United States has a population of approximately 310 million people. The government’s $14.3 trillion dollar debt is the equivalent of $46,580 for every man, woman and child in the United States. Virtually everyone agrees that America’s fiscal path is unsustainable: With a national debt of more than $14.3 trillion dollars, the U.S. borrows forty cents of every dollar that it spends.

On August 2nd, Tim Reid and Ms. Emily Kaiser (business writers for Reuters) noted that Republicans and Democrats were at least united on the fact that America must get its fiscal house in order. However, there is intense fundamental disagreement on how to solve the problem, with Tea (Taxed Enough Already) Party Republicans as passionately opposed to increasing taxes as progressive Democrats are to making deep cuts in the Social Security pension system and other so-called entitlement programs.

Did the August 2, 2011 “debt-limit deal” help to provide a solution to America’s fiscal reform? Answer: No. Yet even with the threat of a catastrophic default as an incentive, and agreement by both political parties that deficits must be brought under control, the debt-limit deal that finally emerged still failed to include robust reform of what are described as “entitlements”.

There is no way to curb soaring United States debt without confronting three of the biggest drivers of American spending: Social Security, Medicaid and Medicare. Deep cuts in any of them represent deal-breakers to large and powerful political forces. By 2047, the non-partisan Government Accountability Office stated that if Social Security, Medicaid, and Medicare are left unreformed, these three programs would devour every cent of America’s tax revenue.

A Growing Economy, But for Who?
On August 1st, David Lawder of Reuters noted that the debt deal offered only small blessings for the U.S. economy.

Lawder stated that Economists were stunned on Friday when data showed the U.S. economy grew just 0.4 percent in the first three months of this year—perilously close to contraction—and picked up unimpressively to 1.3 percent in the second quarter. Against the backdrop of the weak economic recovery, the divided political parties in Congress appear to have agreed on one thing early on in their dispute over how to raise the U.S. debt ceiling: that spending cuts to narrow the deficit should be phased in slowly. They will be phased in from 2013.

Mohammed El-Erian, chief executive of bond fund investment giant PIMCO said that the budget deal “does nothing to restore household and corporate confidence.” He further added that “unemployment will be higher than it would have been otherwise, growth will be lower than it would be otherwise, and inequality will be worse than it would be otherwise.”

Tim Reid and Emily Kaiser concluded that the failure is symptomatic: Every important economic lever must work against a big political stick in the gears.

In short, with more government stimulus “off the table,” the slow-growing economy cannot generate enough jobs to pull down the unemployment rate. That, in turn, means Washington has to spend even more than expected on unemployment benefits, food stamps, Medicaid, and other programs. Therefore, cuts in those programs would then become even more painful.

Finally, with tax hikes “off the table,” tax revenues will be restrained by weak consumer spending and idled labor. PIMCO’s Mohammed El-Erian stated that the debt-ceiling compromise would do very little to fix America’s underlying fiscal crisis. He said, “Remember a sovereign debt burden is defined as total liabilities relative to a country’s ability to service them. So it is not just about the debt stock, the maturity profiles and interest rates. It is also critically about the ability to grow. And this crisis has undermined growth, investment and employment.”

It is apparent that the political process of compromise and acting in the best interest of the American people in Washington, D.C. is broken and that our elected officials are not acting in concert to fix our nation’s fiscal mess. If we are unable to grow our economy through the creation of jobs and new industries then we will not have the needed revenues to pay for the collective debt that we have saddled upon the American people.

Cost cutting is only one half of the economic solution. Et tu, Brute?

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