Dan’s Blog

The Fiscal Cliff We Need

Dan Calandro - Monday, December 03, 2012

In my book I detail five critical market indicators – items that directly impact stocks valuations and the future course of investment – and taxes are one of them.  A debate about tax policy is going on right now in America and, unfortunately, the topic is being clouded by a manmade crisis called the "fiscal cliff."

Before we begin let’s get one thing straight – action that would produce a so called fiscal cliff isn’t being discussed in Washington DC at the present time. A cliff is a dramatic change in direction to the downside. I see the current debate like this: if the Democrats get exactly what they want ($1.6 trillion in new taxes), and the Republicans get exactly what they want ($1.5 trillion in spending cuts) the net effect is near zero. Again, when you’re running trillion-and-a-half dollar deficits a few hundred billion in adjustments are no big deal – certainly nothing dramatic like the word "cliff" inflects. 

This is corroborated in Barack Obama’s most recent budget, where he forecasts colossal deficits into the foreseeable future. Also in that budget he projects national debt will be $20 trillion against a $19 trillion dollar economy when he leaves office. Here’s how that looks in chart form.

12-2a

Governments do not create profit but instead take it from the private sector. Taxes remove money from the free-market and place it in the hands of central government for redistribution. Taxes reduce net profit, and in effect, diminish the value of the dollar and/or the value of goods offered in Markets. This, of course, is not to mention that profit is the mechanism to success and prosperity. When it is minimized, Markets are negatively affected. 

Governments, no doubt, create jobs through their spending programs. Heck, it’s impossible to spend four trillion dollars per year and not create any jobs. Even the right-wingers have to acknowledge this. But they’re not always good jobs, or the right jobs, or long-term jobs.  

When former Vice President Al Gore claimed to have created the internet he wasn’t all wrong. He was part of central government, and if traced back to the beginning, networked communication began in the defense department – a central government function. While Al Gore may have not been the person responsible for the development of the internet, someone in central government certainly was – and long before Clinton came into the White House.  Some people have even attributed the internet’s birth to Ronald Reagan’s sophisticated Star Wars program. Whatever the case may be, while government may have created the internet, it wasn’t the turbine of its success.  

It was the free-market’s introduction of the internet, expanding its application and making it affordable to almost any consumer that made for the great boom of the Clinton ‘90’s. Bill Clinton was a great President. He took over a country that produced $1 trillion in revenue and left one that produced $2 trillion. Nominal GDP went from $6 trillion to $10 trillion and national debt dropped seven full percentage points, from 64% of GDP to 57%. Clinton knew what Reagan knew all too well – American strength is derived from a strong economic position.  

That message is lost in today’s American government.  

Again, the current debate surrounding the "fiscal cliff" is totally bogus. It is about exploiting a manmade "crisis" to coerce the American populous into an extension of poor government policy. Sadly, there is little difference between Democrats and Republicans – liberals and conservatives.  As a result, a compromise in this silly debate would produce little change from current trend-lines – except for one caveat. See the chart below first and then I’ll explain.  

12-2b

The above chart was produced with government figures; the estimates are from Barack Obama’s 2013 budget.  To make this budget "work" a boom was factored into the equation that begins in 2014 and continues strong into ’15 and ’16. 

The last two booms the American economy experienced were the internet driven tech-boom and the housing boom.  Clinton, as we know, raised taxes during the tech-boom and Bush cut taxes during the housing boom. The point here: both presidents had a bona-fide boom during their presidencies.  

The difference between the booms is that the Clinton boom was created by the free-market and the internet and Bush’s was created by government in the form of easy money, easy credit, and irresponsible government intervention in housing via Fannie Mae and Freddie Mac. Nevertheless, both were real and legitimate economic booms where Nominal GDP growth surpassed 6% per year. That same growth is projected in fiscal years 2015 and ’16.

Six percent GDP growth is not common in America and is not an entitlement. Something significant and extraordinary must happen in order to reach that level in such a large $15 trillion market economy. President Obama’s recent budget forecasts this kind of robust growth in 2015 but identifies no specific boom. Of course, the President went into office in 2009 with two specific investment plays: a high risk green energy plan parlayed with a safe bet in healthcare. 

As we know, the green energy investment has proven so far to be a failure. And as mentioned in Supreme Letdown, the Affordable Care Act has no choice but to lead to greater price inflation in the healthcare market, as demand will begin to greatly outweigh supply, and government will become the dominant force in price and coverage. They did the same thing to the housing market – and we know how that turned out.   

For those not considering the value of the U.S. dollar and its steady decline as vital and important inflation is as good as growth. Healthcare inflation – that’s the boom President Obama is forecasting in the second half of his second term. And based on this recent budget, Obama will have to continue mammoth borrowing to make that happen. He plans to leave office with 100%+ debt to GDP in the last five years of his eight year tenure. 

The only other time American federal debt went above 100% of GDP was the World War II years of 1945, ’46, and ’47. The high point of that time, 1946, national debt rose to 122% of GDP. In 1948, two years after American debt hit its highpoint, government spending dropped significantly and debt fell to 98% of GDP. By 1950 it was 94%; and by 1960 it was 56%.  

America is on no such course today.  

That said, the fiscal cliff can only occur with a dramatic change in Market make-up – a significant reduction in government spending only to be replaced by pro-growth policies to bolster free-market activity. (See my Fixing the Market series located in the right rail for more information.) This would right the ship and produce a chart that looks something like this.    

12-2c

A balanced U.S. budget would produce the fiscal cliff depicted in the red line shown above. And while it might sting at first, it would pay huge long-term dividends and turn the Market right-side up. That’s what we really need. 

But sadly, it’s not currently in the debate.

Stay tuned...

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