Avoiding The Fiscal Cliff: Business As Usual In Washington

Includes: DIA, SPY
by: John M. Mason

Am I excited about the fiscal "deal" struck in Washington, D. C. Not really. My forecast before this fiscal cliff "stuff" came along was that the federal deficit would average about $1.0 trillion or so per year for the next ten years. This means that with the federal debt currently at around $16.0 trillion, that over the next ten years the debt of the United States government would be two-thirds larger in 2023 than it is now.

My forecast for the increase in the federal debt since the deal in Washington, D. C. is that, absent a major financial crisis in the future, the debt of the United States government will be about two-thirds larger in 2023 than it is now. In essence, there was a lot of "sound and fury" coming out of Washington in the past week or two but, in the end, nothing has really changed. The reality is that the majority of the elected representatives of the people do not really want to change the way things are.

As David Brooks writes in the New York Times, the "average Medicare couple pays $109,000 into the program and gets $343,000 out, according to the Urban Institute. This is $234,000 in free money. Many voters have decided they like spending a lot on themselves and pushing costs onto their children and grandchildren." In other words, most voters are myopic.

Nouriel Roubini acknowledges this. In the Financial Times, he argues that the modern welfare state is "right and necessary in our age of globalization, rapid technological change and demographic pressures," but maintaining the basic welfare state "implies higher taxes for the middle class as well as for the rich." He goes on that "it will probably take years for the U.S. to confront the reality of its fiscal position and raise revenues to a level sufficient to fund a reformed-but not gutted-welfare state."

That is, taxes will have to go up in the future. However, those currently voting are short-sighted enough to know that they can benefit now and others will have to pay later. But, that is not their worry! And the politicians are helping postpone the cost of this lack of discipline by supporting a Federal Reserve System that is keeping federal borrowing costs to a minimum. As Martin Feldstein argues in the Wall Street Journal with respect to the Fed keeping interest rates so low is that, "The final problem with Fed's unconventional policy is perhaps the most obvious. By keeping long-term interest rates low, it removes pressure on Congress and the Obama administration to deal with budget deficits."

In other words, the deficit is as low as it is because the Federal Reserve is suppressing interest costs in the federal budget. The deficit would be even higher than it is now if the Fed were not maintaining such low interest rates. And the Fed has stated it is willing to continue to keep interest costs low until 2015.

According to Harvard economist Robert Barro, your government is getting away with this program because individuals are not recognizing their future liabilities (as noted by Roubini) of the current "freebies" (as reported by Brooks) or of the possibility of future inflation (as identified by Feldstein). And as long as politicians can continue to get re-elected by protecting the "freebies" is provides the public the deficits will continue to be rolled out.

The argument has been that extending the tax cuts and continuing the deficits helps the "middle class". The big question about this approach: does a government policy of credit inflation really help the "middle class"? Roubini seems to question this. "A deal that extends unsustainable tax cuts for 98 percent of Americans is therefore a pyrrhic victory for Mr. Obama."

That is, taxes will have to go up some time in the future. Or, inflation will have to go up some time in the future. Someone is going to have to pay. And history shows that the people that have to pay in the future are generally not those that are better off financially.

Housing prices are starting to rise. Who is benefiting? I have tried to show that the biggest beneficiaries of this housing bubble may be wealthier individuals: see "Is it too late to get into the housing rebound" and "Is it too late to get into the housing rebound: part two". I have also reported other opportunities for the wealthy to take advantage of the misallocations that are being created by the federal government and the Federal Reserve System.

It is also well documented that the wealthy or well-advised can take advantage of general inflation in a way that the less-wealthy cannot. How do you think the income/wealth distribution in the United States got so skewed over the past fifty years?

Politicians get re-elected because they do what the voters want. I see nothing coming down the road that indicates that the American politicians will change the behavior patterns they have lived with for the last fifty years. As a consequence, I think that federal deficits will continue to run in the neighborhood of $1.0 trillion a year for the next ten years. This credit inflation will create bubbles and other opportunities for some people to make a lot of money. Part of my goal for future posts is to identify these opportunities and report on them in real time. I do not sense that politicians will ever change their behavior … they want to get re-elected!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.