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Over the past few years, policy leaders worldwide have grown accustomed to
kicking the can down the road with each step in this ongoing financial crisis making incremental moves rather than cultivating viable long term solutions. More recent attempts seem to have evolved into simply just trying to kick the can out of the driveway. Now we fear there may not be enough firepower left to simply kick the can over. [Having done so, we are left between the proverbial rock and a hard place.] If lawmakers do nothing, by all accounts we are likely to see a recession. Should lawmakers extend the Bush-era tax cuts, you make no progress towards long term deficit reduction, potentially raising the risk and magnitude of a future financial crisis. [Let me discuss this predicament further and how best to invest in such precarious times.] Words: 1602
So says Matt Erickson (www.lcptactical.com) in edited excerpts from his original article* entitled The Fiscal Cliff: A ‘Taxing’ Predicament
Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited the article below for length and clarity – see Editor’s Note at the bottom of the page. This paragraph must be included in any article re-posting to avoid copyright infringement.
Erickson goes on to say, in part:
What Events Lead Up to Our Predicament?
[In the past 4 years] a tsunami of events [have taken]…place that [have] shook the foundation of the global economy. What began as a crisis in mortgage backed securities, morphed into government bailouts and ownership stakes in public companies (banks, automobile manufacturers, insurers, etc.).In the end, in order to stave off a global depression, central banks from around the world have taken part in coordinated quantitative easing efforts; essentially printing more money/issuing more debt, lowering benchmark interest rates, and establishing themselves as primary buyers of last resort. All of these measures have been taken in an effort to stimulate a slowing global economy, one that as of late has again begun to sputter. Recently, however, many have begun to question what more central bankers can really do? Interest rates are already at or near zero.
This has created a conundrum for both lawmakers charged with the responsibility of managing and drafting fiscal policy, and central bankers navigating monetary policy. It has not been an easy road and certainly each party has taken their turn trying to point their finger at the other, as they struggle to come up with answers, many of which remain unpopular by the masses.
Can the U.S. Consumer Save the Day?
In the U.S., we have witnessed an economy traditionally based on consumer spending for growth, transition to being propped up by government spending yet we all know this can’t go on forever. With government balance sheets bulging out of control they are going to have to step back at some point in time in which case the torch will again be passed to the consumer to provide sustainable economic growth. The question is whether the consumer will be ready. [Read: Are Consumers Prepared to Step up to the Plate?]
With all that has transpired in recent years, the consumer in the U.S. has suffered substantial losses and often incurred significant debts. Many have lost as much as 50% or more on their homes, and perhaps just as much in their investable assets.
At the same time, unemployment remains untenably high, wage growth is anemic, and many consumers continue to face payments on a mountain of debt accumulated during better times (when we all thought things could only go up in value – our investments, homes, incomes, etc.).
In effect, the U.S. consumer is attempting to deleverage their personal balance sheets while governments are massively and unsustainably increasing theirs. Not such an easy task given the circumstances we find ourselves in.
Is a Delicate Balance Between Spending & Taxation Possible?
Elected officials around the world must strike a delicate balance between providing a means to slow down government spending and increase income (taxes levied), without choking off the consumer entirely. Obviously, this is not an enviable task but, as our global leaders grapple with how to solve our long term problems, in the short run they are working to prevent another recession. During the average recession, equity markets historically lose more than 40% of their value. To this point, we have not even gotten back to the highs the U.S. markets achieved in October of 2007. A 40% drop from here would be devastating.
Is There Any Chance for Bipartisan Diplomacy?
So here we are in an election year and, with both parties maintaining such polar opposite positions regarding the fiscal cliff et. al, any chance for bipartisan diplomacy is slim at best. If nothing is done by year end, however, the Bush-era tax cuts will expire, and the ripple effects will be felt far and wide. [Read: Regardless of Who Wins in November the U.S. Is Going Over the Financial Cliff! It’s Just a Matter of Time – Here’s Why]
What May Lie Ahead?
A number of individuals and entities have recently begun to forewarn us about what may lie ahead:
- The Congressional Budget Office has publicly stated that if Congress does nothing to soften the blow of higher taxes and lower spending, the changes would devastate the economy and provoke a recession in 2013.
- Former President Bill Clinton has echoed these statements further, suggesting that tax cuts for people of all incomes, including the rich, should be extended into 2013 to avoid economic harm and allow time for a broader fiscal deal.
- In recent testimony before Congress, Federal Reserve Chairman Ben Bernanke implored lawmakers to take action to address the fiscal cliff, citing that such a “severe” tightening of fiscal policy would “pose a significant threat to the recovery” if it were allowed to proceed. He has also indicated that the Fed would be hard pressed to offset the full effects of such moves.
- The IMF (International Monetary Fund), in its annual review of the US economy warned, “Failure to reach an agreement on near-term tax and spending policies would trigger a severe fiscal tightening… with negative growth early next year and significant negative repercussions on an already fragile world economy.”
While many may look at this as a potential story for 2013, the impact will be felt far sooner.
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Facing what some have estimated to be more than $600 – $700 billion in higher taxes and spending cuts, US companies are already pulling back. Many have already begun to delay hiring and spending, anticipating the impact of pulling hundreds of billions of dollars of purchasing power out of the economy. As cited by Michael Hanson, senior U.S. economist at Bank of America, “You don’t board up the windows when the hurricane is there, you board up the windows in anticipation.”
High net worth investors may soon begin to batten down the hatches as well. With the potential increase in tax rates, many investors holding substantial long term gains may seek to recognize them in 2012 – at what may be substantially lower tax rates than what we are likely to have for the foreseeable future. Pushing profit taking by wealthy investors into 2012 may very well create further selling pressure in the investment markets.
How Will the Upcoming Fiscal Cliff Impact How Much We Pay In Taxes?
Beyond the economic landscape and potential impact on the investment markets, how will the upcoming fiscal cliff impact how much we pay in taxes? According to the Tax Policy Center (a non-partisan research group in Washington), if Congress does nothing, households of all income levels would see their taxes go up:
- low income earners would see their income tax increase from the current level of 1% up to 5%,
- middle income from 14% to 18%, and high income earners from 31% to 38%
- the average tax increase per household would be $3500.00….
I think we can all see where this is going… If lawmakers do nothing, by all accounts we are likely to see a recession. Should lawmakers extend the Bush-era tax cuts, you make no progress towards long term deficit reduction, potentially raising the risk and magnitude of a future financial crisis.
Over the past few years, policy leaders worldwide have grown accustomed to kicking the can down the road with each step in this ongoing financial crisis (making incremental moves rather than cultivating viable long term solutions). More recent attempts seem to have evolved into simply just trying to kick the can out of the driveway and now we fear there may not be enough firepower left to simply kick the can over.
What’s In Store For Us For the Remainder of 2012 and Into 2013?
So what does the mean for the remainder of this year and into 2013? No one can say for sure, but the challenges are formidable, and we all know that US companies as well as the investment markets despise uncertainty. As such, we are currently faced with significant headwinds.
At times like this, rather than engage in a herculean bout of finger pointing, it would be nice to see political leaders come together on a bi-partisan, workable solution. For now, the discord appears too great and in an election year where these guys and gals are trying to get re-elected, it seems to be protocol to try to win by discrediting your opponent, rather than on the virtues of what you bring to the table to solve the problem.
How Should We Invest In Such An Uncertain World?
So here we are:
- bonds are the most expensive they have ever been,
- stocks are up more than 100% in little more than 3 years,
- global growth is slowing, and
- geopolitical risks are on the rise.
Where is an investor supposed to place their hard earned savings for long term growth and preservation of capital?
This is where the investment landscape has changed. What was previously impossible, is now possible. [I’m talking about] ETFs which provide investors with:
- liquidity,
- transparency,
- low cost,
- broad diversification….
- the opportunity to implement tactical allocation shifts [or better yet, asset rotation] that can be utilized to side-step prolonged declines in the investment markets thereby protecting the portfolio from incurring a permanent impairment of capital….
*Source of original article: http://www.lcptactical.com/uploads/Understanding_the_Fiscal_Cliff.pdf
Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.
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