Congress
Avoided The Cliff By Selling America Down The River
Peter
Schiff
3
January, 2013
With
the possible exception of the New York Times’ editorial board (and
the cast of The Jersey Shore), everyone on the planet understood that
the United States Government needs to cut spending, increase taxes,
or both. Instead, after months of political posturing and hand
wringing, the Federal Government has just delivered the exact
opposite, a deal that increases spending and decreases taxes. The
move lays bare the emptiness of budget legislation, which can be
dismantled far easier than it can be constructed.
One
question that should be now asked is whether Moody’s Research will
finally join S&P in downgrading the Treasury debt of the United
States. After the Budget Control Act of 2011 (which resulted from
the Debt Ceiling drama) Moody’s extended its Aaa rating, saying in
an August 8 statement:
“…last
week’s Budget Control Act was positive for the credit of the United
States…. We expect the economic recovery will continue and
additional budget deficit reduction initiatives will be put in place
by 2013. The political parties now appear to share similar deficit
reduction objectives.”
Now
that Moody’s has been proven wrong, and the straight jacket that
Congress designed for itself has been shown to be illusory (as I
always claimed it was), will the rating agency revisit its decision
and downgrade the United States? Given the political backlash that
greeted S&P’s downgrade in 2011, I doubt that such a move is
forthcoming.
For
now, the real budget negotiations have been supposedly pushed later
into 2013, when the debt ceiling will be confronted anew. But who can
really expect anything of substance? The latest deal emerged from a
Congress that is nearly two years removed from the next election. As
a result, Congressmen were as insulated from political pressures as
they could ever expect to be. Nevertheless, they still chose
political expediency over sound policy. If Congressional leadership
(an oxymoron that should join the ranks of “jumbo shrimp” and
“definite maybe”) could not put the national interest in front of
political interests now, why would anyone expect them to do so later?
They will continue to ignore our fiscal problems until a currency
crisis forces their hand. I expect deficits to approach $2 trillion
annually before Obama leaves office. Unfortunately, at that point the
solutions would be far more draconian than anything economists and
politicians are currently considering.
In
light of the extensions of the popular middle class tax rates, the
loudly trumpeted tax increases on those individuals making more than
$400,000 (and couples making more than $450,000) will not be enough
to translate into higher tax revenues. Instead they will result in
perhaps $60 billion per year in new revenue to the Federal government
that will be more than offset by the new spending announced in the
agreement. In fact, with the likely passage of the $60 billion
Hurricane Sandy aid package, it will have taken Congress less than
one week to spend all of the projected revenue.
But
the tax increases will push many individuals in high tax states like
California and New York into paying more than 50% of their income in
taxes. While many economists are cautioning that higher taxes on the
wealthy will take a bite out of spending, in my opinion it is more
likely to result in lower business investment, which is far more
detrimental to the economy. When faced with diminishing discretionary
income, most rich people would sooner cut back on savings and
investment than they would on health care, education, home
improvements and vacations.
But
it should be clear that the rate increases are just the opening
crescendo in a symphony of tax hikes on the nation’s
entrepreneurial class. President Obama has recently stated that he
will consider needed cuts in spending and entitlement programs only
if they are coupled with additional tax increases on the wealthy. In
other words, as far as the President is concerned, the hikes included
in the budget agreement that was just passed didn’t count for
anything.
It
cannot, or should not, be denied that Washington’s latest fig leaf
will have a major impact on the markets. The New Year’s “relief
rally” is understandable given the clear implications that the
government will simply print its way out of trouble for as long as it
can. In the past, fiscal profligacy was held in check by investors
who would sell bonds and push interest rates higher whenever it
appeared that the government was not serious about national solvency.
But with the Federal Reserve now buying the vast majority of U.S.
government debt, no such roadblock exists. With monetary and fiscal
stimulus pushing up stock and bond prices, and no immediate fear of a
rally-killing spike in interest rates, there is no reason to stay on
the sidelines. Markets are now driven by stimulus, not fundamentals,
and the stimulus is firmly at the wheel. (For more on this – see
the article in the January edition of Euro Pacific’s Global
Investment Newsletter). But it is important to look at the nature of
the rally. Most significantly we would bring investors’ attention
to the increase in gold and oil and other assets that are expected to
outperform in an inflationary economy. Our new Newsletter edition
also includes an analysis of some of the more promising overseas
markets.
But
by taking the nominal risk out of investing, the government is
insuring that the risks to the U.S. economy will grow exponentially.
We are now – and will remain – a debt-fueled economy for as long
as the rest of the world permits this to continue. But this is no way
to create real, sustainable economic growth. On the contrary, it will
simply permit the growth of government, the depletion of economic
vitality, and ultimately the collapse of the U.S. dollar.
In
the meantime, President Obama and Congressional leaders will take
credit for a tax cut that is in reality a huge tax increase in
disguise. Government spending is the real source of taxpayers’ pain
and it is only a matter of time before the bill comes due in the form
of inflation. See our Newsletter for fresh analysis as to why
inflation may already be higher than you think. Because the deficits
will grow even larger, more purchasing power will be lost in this
manner than would have been lost had all the Bush tax cuts been
allowed to expire. In addition, though entitlement cuts were taken
off the table, the real value of benefits could be slashed, as cost
of living adjustments fail to keep up with skyrocketing consumer
prices. That’s a Fiscal Cliff that will not be so easy to avoid.
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