Charles Ortel is a managing director of research firm Newport Value Partners. Previously he was a managing director and head of worldwide mergers and acquisitions at investment bank Dillon Read, followed by leadership roles at The Bridgeford Group and The Chart Group.
Harlan Levy: What do you think of S&P's downgrade of U.S. Treasuries and its effect?
C.O.: Plutarch observed almost two millenia ago: "The real destroyer of the liberties of the people is he who spreads among them bounties, donations and benefits." The U.S. has been given fair and ample warning: The big message here is that borrowing money (because we can) to over-pay too many public sector workers too much money is a route to economic perdition. Most alarming is action taken regarding the Federal Reserve. We know the U.S. government is stretched--I do not see signs of strength in the financial statements of our "lender of last resort."
The U.S. has finally lost absolute control of its financial destiny. The wise investor will take remaining profits off the table and allocate capital to the few remaining currencies that are most likely to be run prudently: the Norwegian Krone, the Singapore dollar, the Canadian dollar, and to stores of value like gold. I continue to believe there is a large “margin of danger" in most equities.
Politically, we approach a convulsion (as Jefferson predicted) where our rights "will expire or be revived." Sadly, the soonest results will become known is November 2012. Volatility spikes will become the norm until then, which certainly punctures the tranquility of a "buy-and-hold" mentality that was so much fun from 1981 to 1999.
H.L.: What does stock market volatility tell you?
C.O.: Investors have lost confidence in officials and major participants’ activities in the global economy since 1999. Investors have great difficulty following reports of progress and then seeing repeated disappointments in efforts to re-prime the economy.
H.L.: Are we headed for recession if not a long soft patch?
C.O.: I think that we have been in a recession since September 2008, when advanced economies entered financial purgatory. Policy-makers have been jawboning the wider world in hope that historic fiscal and monetary stimuli would reignite economic growth. But the facts remain that there are massive structural imbalances that have not been addressed.
The biggest imbalance has been between the global supply of accessible labor and the demand for labor inside advanced economies. Excess supply is creating relentless downward pressure on private-sector incomes, and recent government actions under both the Bush and Obama administrations have pushed up the cost of labor just as corporations have gained access to more and more foreign supplies of labor, so we’re past a breaking point.
Internally, judging by the cacophony seen in the most recent debt ceiling drama, we are not going to have any meeting of the minds until we get through the 2012 election. That means we’re running the gantlet until January 2013, when the new team is seated in Congress. We have to hope between now and then that there won’t be major geo-political adverse developments that further frustrate our ability to rewrite the economy.
We are going to be navigating internal political challenges while also remaining fearful of suffering external geopolitical attacks. So this is about the worst possible time for allocating risk capital to equities, because equity prices haven’t gone down enough to compensate investors for all these risks.
H.L.: Is it clear that Congress’s dealing with the deficit instead of doing anything about joblessness was a huge mistake?
C.O.: No. Not at all. The total amount of government spending inside the U.S. is not simply federal spending, which is about $3.6 trillion a year. It’s more like $5.6 trillion if you include state and local.
So government spending is vast already, and it is abundantly clear that more government spending at this point does not materially change the interest of investors to commit capital to the U.S. in hopes of creating more jobs. The size and scope of government is already too big.
We’re well past the point where deficit spending on public-sector initiatives is likely to have a positive impact on economic growth. We’ve already spent too much. And economist John Maynard Keynes never intended for governments to borrow money to fund stimulus activity. Instead, his theory was that savings should be channeled to stimulus, if savings were available.
If the U.S. were to lower its corporate income tax rate to 10 percent and commit to keeping its rate at that level for an extended period of time, it would find enormous internal capital flows. And if the U.S., which is actually under-populated compared to Europe and Japan, were to aggressively compete for educated, family-prone, business-centered immigrants, who are interested in developing firms that had realistic export prospects we would rekindle the spirit that helped America flourish after 1945.
Thirdly, we would have to change the mission of government. We would have to abandon wars on concepts, such as drugs, terror, poverty, and then resize the number of people employed by the public sector to more realistic levels.
Furthermore, with regard to elected officials, the system of checks and balances manifestly does not work to the economic benefit of our citizens. Elected public sector officials should not receive pensions. High-level public sector officials should not be allowed, as they currently are, to sell their holdings on a tax-advantaged basis when they enter government. All elected officials should be subjected to the same insider-trading prohibitions, which is not the case.
If elected officials can’t get a budget agreed on time, they shouldn’t be paid for the remaining term. It’s inexcusable, with the challenges we face, that we haven’t had a budget at all for the past two years.
H.L.: Shouldn’t Congress start spending by enacting a jobs program involving fixing our infrastructure among other basic needs?
C.O.: Absolutely not. What Congress should consider and what the American people should demand is repeal of laws that require governments to use high-cost union labor for infrastructure projects.
If our idea is to get the largest number of people back to work, then surely it makes sense to start by repealing this New Deal relic. Beyond that, we have to think about downsizing, indeed perhaps tearing down infrastructure built in the 1930s through 1970s, which perhaps simply doesn’t make sense in 2011.
H.L.: The debt ceiling has been raised, and spending will be cut in this weak economy. But will that stop the U.S. dollar from falling?
C.O.: Unfortunately, no. Our exports, at $1.7 trillion, are already very substantial, and our local competition inside prime target markets is only getting stronger. So it is far from clear that cheapening our currency will alone result in growing our exports materially. But it’s very clear that devaluing our currency will lessen the value of our national collateral, just at the time that our lenders are becoming more insistent, more anxious, and even more militant.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.