By Charles Webb
We're now a week into yet another round of Washington dysfunction
with no indication as to how the funding impasse is going to get resolved. Clients
are starting to call us worried about what they're hearing in the news and wondering
what this means to their finances. Clearly, people are worried. But then that's
exactly what the politicians want. They want us worried. They want to make the
situation seem as scary as possible to pressure the other side to move. It's
wrong, immature and probably immoral. It's also classic politics.
As your financial advisor, it's our job to keep our finger on the pulse of world
events and try to understand how these various issues may impact your portfolio
and ultimately your financial goals. So here's our take on this latest fiasco.
As I'm sure most of you know, there are two issues on hand that need to be resolved
in Washington. The first is passing legislation that will fund the government's
expenditures for this year and the second is passing a bill to allow the government
to borrow more money.
The first issue to hit us dealt with funding the government's current expenses.
Unlike most businesses, the Federal government's fiscal year runs October 1st
thru September 30th. Every year Congress must appropriate funds to pay for its
upcoming year's expenses. Without that legislation, come October, it technically
doesn't have the funds to pay its bills. It's important to note that this doesn't
impact all spending but only some. What we have now is a partial stoppage of
one government. I say one government because it is not "the government"
but only one of our governments. This has no bearing on state or local government
activities where the vast majority of our services come from. In fact, most
people would be hard pressed to identify something that the Federal government
does for them on a daily basis.
In our opinion, this aspect of the crisis is really a non-event. Legislation
has already been passed to see that furloughed workers will get their back pay
once this is over. So we're not going to have some big impact on consumer spending
because of all these people out of work. Some specific contractors or specific
industries will see their revenue cut for the month. Not exactly something to
put the markets in a tailspin.
Instead, what we have are a bunch of people whose power comes from spending
our money unable to do so and screaming about it. It makes great news and eye
catching headlines but has very little to do with our day to day lives. There's
no better proof than the extremes the Feds are trying to go to make the regular
folks feel their pain. The pettiness is on full display at open air venues where
barricades have been paid to be erected and guards paid to keep visitors out
in the name of the park being closed.
The second aspect of this crisis dealing with the debt limit is a different
story. The implications of not extending our credit limit reach far and wide.
Because the prospects of the U.S. not living up to its debt are so ominous,
no one is really taking that seriously. If that possibility were in the cards,
the bond market would have crashed by now.
The importance of Treasury securities is the byproduct of the U.S. dollar. Treasuries
function as a holding place for dollars used in trade and since 1945, most of
the world has been on a dollar standard. Today, for emerging markets outside
of Europe, the dollar is used for invoicing both exports and imports, it is
the intermediary currency used by banks for clearing international payments,
and the intervention currency used by governments. To avoid conflict in targeting
exchange rates, the rule of the game is that the U.S. remains passive without
an exchange-rate objective of its own.
Countries like China that run large trade surpluses with the U.S. find themselves
with ever-growing balances of dollars on their hands. They have to do something
with this cash and they find themselves with little alternative but buy U.S.
Treasuries with those dollars. The lack of alternatives is the key. If there
was an alternative, you would see an immediate drop in the number of investors
lining up at the Treasury auctions. It is this interdependency that makes the
thought of a U.S. default so unimaginable. International chaos would ensue if
we were not able to resolve the current dispute. If you're thinking of getting
out of the market (any market) to avoid the fallout from a default, good luck.
There's nowhere to go.
So we can only conclude that none of the players involved are
really going to let the country default but are posturing themselves politically.
The President wants his spending priorities unfettered and the Republicans want
to limit those priorities. Let's be clear that it is entirely appropriate and
necessary to have to debate the debt limit. This is an important check on the
various branches of government. As much as all those involved disagree on details,
they all agree that the debt limit should be limited by Congress and only expanded
by a consensus. There is no greater proof than the fact that both parties, historically,
only raise it enough to cover a year or two's worth of borrowing at a time.
Otherwise, just set the limit to fifty trillion and be done with it. Even the
President, who now seems to detest the idea of debating the debt ceiling, once
argued for it. Here's what then Sen. Barack Obama said in 2006, when President
Bush sought an increase in the debt ceiling:
"The fact that we are here today to debate raising America's debt limit
is a sign of leadership failure. It is a sign that the U.S. government can't
pay its own bills. It is a sign that we now depend on ongoing financial assistance
from foreign countries to finance our Government's reckless fiscal policies.
. . . Increasing America's debt weakens us domestically and internationally.
Leadership means that "the buck stops here." Instead, Washington is
shifting the burden of bad choices today onto the backs of our children and
grandchildren. America has a debt problem and a failure of leadership. Americans
deserve better."
Here's what he said last Thursday:
"If the borrowing limit isn't raised, "the whole world
will have problems, which is why, generally, nobody's ever thought to actually
threaten not to pay our bills,"... "I'm going to repeat it: There
will be no negotiations over this,''
The outstanding debt in 2006 was 8.5 trillion. Today it's about 17 trillion.
The difference now is that the outstanding debt balance has become so large
so quickly that the consequences of a runaway deficit are much greater than
ever. This has led to a much greater philosophical divide on the issue. It's
also less likely to be resolved in a timely manner and pushed right up to the
deadline as we see today. Unfortunately, this may be the new normal until the
government can get back on a sustainable fiscal path - regardless of who is
in office. This is yet another reason to get our fiscal house in order.
So here's where we are today. The Dow is off about 800 point's or roughly 5%
and still headed lower. With your current investments you really have two choices
- get out or ride it out. Our belief is that whatever decline in the stock market
prior to a resolution will be reclaimed by the end of the year. If that's the
case, it's best to ride it out. The challenge to getting out is trying to figure
out when to get back in. Investor fears usually only subside after the recovery.
That's usually after the market is higher than where you sold it.
The greater threat to our financial future is for the national debt to continue
this path and not a selloff in the stock market lasting a couple of months.
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