15/06: The Nero Effect
It is said that Nero fiddled while Rome burned. While there is apparently no proof of this assertion, Nero was deeply unpopular during his reign in first century Rome. He was thought to be self absorbed and selfish, attentive only to his own needs and those of his immediate cronies.
Can we draw a comparison to 21st Century United States?
Recent efforts of the US Senate to produce a FY 2006 budget resulted in a proposal that, if adopted, would expand the US Federal Budget deficit by about $100 billion each year. More than all of this proposed red ink (approximately $120 billion in proposed tax cuts and $20 billion in proposed spending reductions on health education, etc) stemmed from proposals to provide further tax cuts for US workers earning more than $150,000 per year.
On the House of Representatives side the legislators were more frugal, cutting proposed spending more than enough to make up for the proposed tax cuts. Included in the House version of the 2006 Budget are deep cuts (about $65 billion over 5 years) in the Medicaid Program. Interestingly, this is the same program that paid for Terri Schiavo’s hospice care while she lived. The combined impact of these proposals will be, if adopted, to cut services and benefits for the poor while rewarding high-income US tax payers.
In other news, the US Government will borrow over $100 billion during this current fiscal year from the Social Security Trust Fund in order to keep the stated deficit in the $400 billion range. Further, the US trade deficit (US exports minus US imports) ballooned last year to more than $600 billion or about 6% of GDP.
Does it matter? The Vice President has been quoted as saying that “…Reagan proved that deficits do not matter”, (see Paul O’Neill). More recently the President and his cabinet have averred that budget discipline is important but there seems little near term hope of real change.
When in Doubt Raid the Piggy Bank
So where are we? Most of us would not withdraw the money we had saved over many years for our (now 17 year old) child’s education fund to pay for a trip to Las Vegas. And if that education fund looked a little short we would work hard to top it up so as to provide the best opportunity for said child.
Not so our government. In the face of looming retirement of the baby-boom generation our annual budget deficit is approaching 4% of GDP (more if you count the funds supplied by the Social Security Trust Fund). So we are borrowing from all Americans (Social Security) to fund tax cuts for high-income families just as the need for Social Security payments begins a steep increase.
Does this make sense to you? Combined with our trade imbalances we are becoming the greatest debtor in the history of the world. Most banana republics do better than this. Does this make for a good investment climate? My answer is no. More importantly what do our bankers (China, Japan, South Korea, etc.) think? Apparently they have begun to diversify away from the US dollar.
Our Friends in China
At the same time there is a new move afoot in Congress to limit international trade (mostly imports from China). Sponsored by several “free-trade” Senators, Bill 295 would levy a 27.5% tariff on Chinese goods imported to the US. The idea is to bluff China into holding the line in the growth of their exports to the US or face punitive tariffs.
Yes, you do see this clearly. We are angry with the primary supporter of our profligacy (China who sells us goods each month worth about $10 billion more than they buy from us and then lends the $10 billion back to us so we can do it again next month) and yet we expect them to continue lending to us in the meantime. Incredible is it not? It is analogous to the junkie being mad at the pusher for causing his problem. Fortunately, proposed legislation does not always become law. However, given the tight relationship of the current Administration and big business in the US, and the increasing complaints about China coming from that quarter, it seems likely that trade conflict will grow.
I hope you are still following the argument. We are working overtime to blame others for our profligacy that has been many generations (in trade anyway) in the making. We are also spending the monies accumulated for our collective retirement on tax cuts. And the fiscal discipline that was so painfully enacted in the Clinton years (and due to bi-partisan efforts) is just so much history.
Am I the only one who thinks that we need to spend and consume less and save more?
Is DC Fiddling While America Burns?
Against this backdrop it was no surprise to this observer that financial assets declined modestly in the first quarter. We are entering a period of major structural adjustment in the US that will be painfully forced upon us. The shift from a nation committed to borrow and spend more and more, to a culture of thrift will be painful, difficult and take many years to adjust to.
The investment implications of this coming change are murky. In general consumer activity should slow, interest rates decline, stock returns weaken, unemployment rise and real estate deflate. I know it seems improbable that real estate will not go up forever but current prices have a bubble like feel in many markets. If real estate does decline in value the negative Wealth Effect (our propensity to spend a % of increased wealth) may well cause an abrupt slowdown in consumer spending.
Alas, the timing of this transition is not at all clear. Given the imbalances in trade and the US budget, the decline in real wages for half of US workers (those families below the median) and the growth in US poverty it seems likely that these changes will be forced upon us sooner rather than later. But there is no guarantee. We might borrow our way into further trouble for years to come.
Given the usual uncertainties and the growing risks posed by our government’s fiddling and our own over-consumption, it seems wise to maintain a conservative asset allocation (relative to your normal posture). This should include broad diversification, modestly less US stocks, and more than usual international exposure. During this period of rising interest rates it also seems prudent to gradually increase bond weights and duration.
The one thing to remember is that just when we think trends will go on forever they change. And change we will, most likely involuntarily. That change will bring about realignments in our economy and new opportunities. So please resist the normal human tendency to extrapolate the recent past into the indefinite future. Prepare for the change and remember the old adage, “Chance favors the prepared mind (Pasteur)”.
O. Sam Folin, CFA
April 2005
Can we draw a comparison to 21st Century United States?
Recent efforts of the US Senate to produce a FY 2006 budget resulted in a proposal that, if adopted, would expand the US Federal Budget deficit by about $100 billion each year. More than all of this proposed red ink (approximately $120 billion in proposed tax cuts and $20 billion in proposed spending reductions on health education, etc) stemmed from proposals to provide further tax cuts for US workers earning more than $150,000 per year.
On the House of Representatives side the legislators were more frugal, cutting proposed spending more than enough to make up for the proposed tax cuts. Included in the House version of the 2006 Budget are deep cuts (about $65 billion over 5 years) in the Medicaid Program. Interestingly, this is the same program that paid for Terri Schiavo’s hospice care while she lived. The combined impact of these proposals will be, if adopted, to cut services and benefits for the poor while rewarding high-income US tax payers.
In other news, the US Government will borrow over $100 billion during this current fiscal year from the Social Security Trust Fund in order to keep the stated deficit in the $400 billion range. Further, the US trade deficit (US exports minus US imports) ballooned last year to more than $600 billion or about 6% of GDP.
Does it matter? The Vice President has been quoted as saying that “…Reagan proved that deficits do not matter”, (see Paul O’Neill). More recently the President and his cabinet have averred that budget discipline is important but there seems little near term hope of real change.
When in Doubt Raid the Piggy Bank
So where are we? Most of us would not withdraw the money we had saved over many years for our (now 17 year old) child’s education fund to pay for a trip to Las Vegas. And if that education fund looked a little short we would work hard to top it up so as to provide the best opportunity for said child.
Not so our government. In the face of looming retirement of the baby-boom generation our annual budget deficit is approaching 4% of GDP (more if you count the funds supplied by the Social Security Trust Fund). So we are borrowing from all Americans (Social Security) to fund tax cuts for high-income families just as the need for Social Security payments begins a steep increase.
Does this make sense to you? Combined with our trade imbalances we are becoming the greatest debtor in the history of the world. Most banana republics do better than this. Does this make for a good investment climate? My answer is no. More importantly what do our bankers (China, Japan, South Korea, etc.) think? Apparently they have begun to diversify away from the US dollar.
Our Friends in China
At the same time there is a new move afoot in Congress to limit international trade (mostly imports from China). Sponsored by several “free-trade” Senators, Bill 295 would levy a 27.5% tariff on Chinese goods imported to the US. The idea is to bluff China into holding the line in the growth of their exports to the US or face punitive tariffs.
Yes, you do see this clearly. We are angry with the primary supporter of our profligacy (China who sells us goods each month worth about $10 billion more than they buy from us and then lends the $10 billion back to us so we can do it again next month) and yet we expect them to continue lending to us in the meantime. Incredible is it not? It is analogous to the junkie being mad at the pusher for causing his problem. Fortunately, proposed legislation does not always become law. However, given the tight relationship of the current Administration and big business in the US, and the increasing complaints about China coming from that quarter, it seems likely that trade conflict will grow.
I hope you are still following the argument. We are working overtime to blame others for our profligacy that has been many generations (in trade anyway) in the making. We are also spending the monies accumulated for our collective retirement on tax cuts. And the fiscal discipline that was so painfully enacted in the Clinton years (and due to bi-partisan efforts) is just so much history.
Am I the only one who thinks that we need to spend and consume less and save more?
Is DC Fiddling While America Burns?
Against this backdrop it was no surprise to this observer that financial assets declined modestly in the first quarter. We are entering a period of major structural adjustment in the US that will be painfully forced upon us. The shift from a nation committed to borrow and spend more and more, to a culture of thrift will be painful, difficult and take many years to adjust to.
The investment implications of this coming change are murky. In general consumer activity should slow, interest rates decline, stock returns weaken, unemployment rise and real estate deflate. I know it seems improbable that real estate will not go up forever but current prices have a bubble like feel in many markets. If real estate does decline in value the negative Wealth Effect (our propensity to spend a % of increased wealth) may well cause an abrupt slowdown in consumer spending.
Alas, the timing of this transition is not at all clear. Given the imbalances in trade and the US budget, the decline in real wages for half of US workers (those families below the median) and the growth in US poverty it seems likely that these changes will be forced upon us sooner rather than later. But there is no guarantee. We might borrow our way into further trouble for years to come.
Given the usual uncertainties and the growing risks posed by our government’s fiddling and our own over-consumption, it seems wise to maintain a conservative asset allocation (relative to your normal posture). This should include broad diversification, modestly less US stocks, and more than usual international exposure. During this period of rising interest rates it also seems prudent to gradually increase bond weights and duration.
The one thing to remember is that just when we think trends will go on forever they change. And change we will, most likely involuntarily. That change will bring about realignments in our economy and new opportunities. So please resist the normal human tendency to extrapolate the recent past into the indefinite future. Prepare for the change and remember the old adage, “Chance favors the prepared mind (Pasteur)”.
O. Sam Folin, CFA
April 2005
