EmailMuch political blood has been spilled over the recent squabbling in the nation's capital over the U.S. budgetary problems. As this is written, it appears as if the short-term problem of raising the debt ceiling has been resolved. The real problems -- the burgeoning U.S. debt and lackluster economic growth -- are far from solved. The war over these issues has barely begun.
Assessment of the Budget Deal
The deal is a joke.
It doesn't seriously address the major budget issues the country faces.
It is a political compromise that covers up the latent ideological issues that will drive U.S. politics in the years ahead.
The best that can be said of the tragi-comedy of the past few weeks is that the nation has embarked on a serious discussion of how to deal with the impending debt crisis the U.S. faces.
The worst is that the deal contains a collection of tried-and-true political gimmicks that allows Congress to avoid addressing critical issues for another year-and-a-half until after the next election.
Consider:
1) All of the projections are based on 10-year estimates. Most of the cuts can
be back-loaded to future years. That leaves plenty of time for change, no matter
what is said today.
2) Of the presumed cuts in spending, $917 billion is expected in discretionary
spending. There might be some real constraint here, but this is also the same
category that includes the impossible-to-kill, but nonsensical ethanol
subsidies.
3) The other $1.5 trillion in cuts will come from yet another
commission-committee of distinguished wise men to address entitlements. There
will be four Republicans and four Democrats on the committee. There supposedly
will be mandatory cuts even if there is no consensus. But this is a law. Laws
get changed all the time. These commissions have a track record of failure and
there is a great risk of failure here. This risk will soon be recognized once
the fight over the nature of the committee begins, and could become worse once
any changes to entitlements are announced.
4) A Balanced Budget Amendment vote in congress, as required by this deal, won't
win approval and would require dramatic cuts in spending that proponents don't
seem to recognize. It is not a serious solution. It is pure political theater.
The major problem in all this is that the deal does not directly address the overriding problem underlying the budget problem -- Medicare (health care for the elderly), Medicaid (health care for the poor), and Social Security.
The deal allows the special committee to address Medicare and Social Security, but if no consensus is reached, the automatic cuts that are triggered cannot affect Social Security, Medicare (other than payments to doctors, and those cuts have always been reversed when previously enacted), or programs for low-income people. Half the cuts would come from defense.
It was probably unrealistic to assume that this debate would produce any real, substantive action on the underlying budgetary problems that the U.S. faces simply because the debt ceiling came up.
Nevertheless, the back-slapping, self-congratulatory attitude of the political establishment has to be tempered by the realization that the heavy-lifting has not been addressed.
The Real Debate
The reason that the true problems have not been addressed is that the recent dance in Washington was only tangentially about financial issues.
There was far more than partisan politics in this debate.
The dominant underlying issue was the role of the modern, Western social welfare state in the future of America.
This is the most ideological battle in Washington since Ronald Reagan hit town, and this opening skirmish indicates that it may soon be the most bitter ideological battle since the Civil War.
Many Democrats view the current deal as a first step in the possible dismantling of the social welfare state. They view entitlement programs (as well as a progressive tax code) as essential to countering the economic and moral inequalities caused by unfettered capitalism. They hate this deal and will fight spending reductions with every fiber in their soul.
Many Republicans agree that this could be the first step in the possible dismantling of the welfare state. And they will fight for it. They believe they were sent to Washington to end runaway spending and to control government excess. Not doing so, they believe, will undermine prosperity and reduce freedom and liberty. They hate this deal and will fight for additional real spending cuts with every fiber in their soul.
In this war for the future of America, this debt ceiling deal is simply an opening skirmish.
It is very arguable that Republicans won this round, because the focus was on spending restraint.
There is no reason to believe, however, that Democrats will accept this defeat. They will retrench and fight every spending cut in every way possible. History suggests that persistence in favor of government spending works.
Don't bank on the spending cuts until the laws are passed.
And don't bank on this deal laying to rest the underlying conflict over the future of the welfare state in America. The war has just begun.
What It Means for the Financial Markets
The deal is good news for the stock market. The threat of default, or of an immediate, drastic cut in government spending because the cash simply isn't there, has been at least temporarily eliminated.
The deal is not convincing, however, in terms of seriously addressing the long-term budget problems of the United States.
The market focus may soon turn to the long-term deficit if U.S. Treasuries are downgraded.
The increase in the debt ceiling simply eliminates a feared negative. It does next to nothing to boost the long-term argument for stocks.
The Other Major Budget Problem
It is almost three years now since the U.S. economy collapsed at the end of 2008.
The longer this languid recovery continues, the worse the budget crisis gets. The decline in federal revenue from 2008 to 2009 as a result of the recession was $419 billion, from $2.524 trillion in 2008 to $2.105 trillion in 2009.
Revenue is expected to have recovered about $100 billion over 2010 and 2011. And, CBO forecasts are for a further increase of approximately $300 billion in 2012, $400 billion in 2013, and over $300 billion in 2014. That would take revenue up to $3.205 trillion, up from an estimated $2.230 trillion in 2011.
CBO forecasts therefore call for a 44% increase in federal revenues in three short years from 2011 to 2014, with revenues increasing approximately $1.00 trillion. Again, that is in just three years.
Over the ten years that the debt ceiling deal covers, and using the same methodology for cuts, revenues are forecast to rise about $17 trillion.
In that context, any potential shortfall in revenue will swamp this recent budget deal.
A shortfall in revenue cannot only not be discounted, it is now likely given the extremely disappointing GDP report last week. CBO estimates are based on a return to historical real GDP growth near 3% or above. The longer it takes for that to happen, the worse the budget forecasts will get.
Market Concerns
The ongoing U.S. economic difficulties are a serious problem for the stock market and for the U.S. budget.
There are those who argue more government spending is needed to stimulate economic growth, and those who argue less government spending is needed. We aren't going to take sides in this argument, but there is no denying that the failure of the U.S. economy to gain any traction on growth is a major problem for the stock market and more significant for deficit forecasts than this new budget deal.
U.S. stocks have done exceptionally well on a surge in profits the past two years. A great deal of this has been due to international exposure. That's fine, but over the long term, profits derived from the U.S. need to increase due to growth.
The ongoing sluggishness of the U.S. economy may well turn into the next stock market obsession as soon as the end of this week. This deal will become yesterday's news fast, at least until the probable reports later this year that the commission/committee appears deadlocked.
What It All Means
The markets can breathe a huge sigh of relief.
Now, it is time to recognize that the deal did almost nothing to address the growing problem of the U.S. budget deficit. The issue of runaway entitlement spending is unresolved.
The GDP report last week, reflecting less than a 1% annual growth rate for the first six months of this year, is a screaming red flag. The recession supposedly ended two years ago. Slow growth will hamper federal revenue growth and have a far larger impact on the deficit than the supposed "cuts" in this deficit deal.
We have long believed that this is not a typical economic cycle. Recovery following credit recessions takes a lot longer than recovery from typical recessions. It simply takes a long time to clear bad debt and renew credit growth cycles. The current economic trends, however, are worse than just about anyone anticipated.
The risk of a double-dip recession has increased. If that were to occur, the damage to profits would be severe.
The damage to the U.S. budget would be even worse. It would swamp the supposed savings in this deal. It would mean that the drama would soon start all over again, and this time the battle lines have been drawn.
The next couple of years could see an intense war over the role of government, the welfare state, taxes, and the budget deficit.
This deal was only the opening skirmish in that coming war.
