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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. However, the increases will result
in many individuals in high tax states like California and New York 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. We would bring investors' attention to the increase in gold and oil
and rally against the dollar of every major currency except the Japanese yen
(which is being deliberately debased by a newly elected government). 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 entitlements 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.
Peter Schiff is the CEO and Chief Global
Strategist of Euro Pacific Capital, best-selling author and host of
syndicated Peter Schiff Show.
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