Superfail

Who is surprised that the United States Congress Joint Select Committe on Deficit Reduction, or the so-called "Supercommittee", will fail to find consensus on mandated budget cuts of $1.5T over ten years?  What makes this failure all the more absurd is the fact that $1.5T over 10 years is WHOLLY INADEQUATE and wouldn't even begin to set upright the fiscal ship of state.

It will be interesting to hear the blame game on the national talk shows, but I think one observation is important here: on average, the members of this committee (and the ranking members of the House and Senate for that matter) have served for a LONG TIME.

For example, the Senate members of the committee have served for an average of 15.5 years (and, this average takes into account two freshman members who haven't even served a full year yet), while the House members have served and average of 13.3 years.

How could this degree of incumbency possibly contribute to Superfail, as people are starting to call this fiasco, you might ask?  Because anyone who has served in Congress for so many successive terms (an average of over three in the case of the Senators if you discount the freshman, and an average of nearly seven in the case of the House members) has obviously placed a higher premium on their own political survival than on making the courageous decisions that they are empowered and obligated by the U.S. Constitution to make.

What has been sadly lost in terms of an ethos in Congress is the notion of the elected official as a public servant who leaves a successful business, farm, medical practice, etc., for a short time in order to advance the public good and then returns to private life.  Because of the exponential degree by which Congress has amassed authority over the decades, our elected officials have become addicted to the power of their office and cannot abide to surrender the reigns, even when it is time for them to move on.  Instead, Congress has gradually become overwhelmed by career politicians who have mastered the art of survival at the expense of the political leadership and risk-taking that is sorely needed.

That is why I believe that the time is come to once again debate the idea of congressional term limits in order to inject fresh blood into the body politic.

If the members of the "Supercommittee" cared more about the future of this great nation than their own prospects for re-election, they would have reached an agreement and sent a message to the country that democracy DOES work.  Instead, they failed and we are all that much more cynical as a result.

S&P Flubs Another One

In an admitted "technical error", the international credit rating agency Standard & Poors downgraded French sovereign debt on Thursday, triggering extreme market volatility, before reversing the downgrade and restoring France's AAA rating.

This incident brings to mind S&P's downgrade of U.S. sovereign debt from AAA to AAa earlier this year.  At the time, S&P acknowledged that they had made significant mistakes in their longer-term fiscal projections, but that these errors did not substantively change the U.S. credit outlook, sparking outrage and cries of foul play from the Treasury Department.

Also, it is important to recall that S&P had maintained investment-class ratings on the mortgage-backed derivatives, called CDO's, literally up to the very moment that the market for these securities collapsed, leading to the demise of Bear Stearns and Lehman Brothers.  When challenged by a Senate panel as to their decision to grant CDO's an investment-class rating, when in reality they merited junk status, executives for S&P stated that their credit rating decisions are merely "opinions" that enjoy First Amendment protections. 

"Opinions shielded by the First Amendment"?  They have got to be kidding.  The posts on my blog, for which I receive no remuneration, are opinions shielded by the First Amendment.  Credit ratings are the result of professional analysis that the credit rating agencies are fee-contracted to perform, and these ratings are the basis on which important investment decisions are made.  If mistakes are made that result in money lost by investors who have paid a credit rating agency for their guidance, then the credit rating agency should be held be liable for civil damages.

I strongly urge Congress to enact legislation regulating the credit ratings agencies and providing for a mechanism by which they can be held legally accountable for their malfeasance.

Eat The Rich

There seems to be a serious backlash against the rich afoot these days in America. Statistics are bandied about as to the degree of polarization of wealth, such as that the top 1% in terms of net worth surpass the bottom 90% COMBINED. While this statistic is stark in its imagery, there has always been a certain degree of polarization in wealth in this country, so this is really nothing new.

What is different at this time is that the U.S. fiscal deficit and national debt are off-the-charts out of control and have to be brought down soon. And, who is in a better position to make a down payment on our children's future than the ones with all the money?

Therefore I believe we should consider the following policy changes:

1. Restore the Clinton-era tax brackets and tax capital gains as regular income. Capital gains are currently taxed at a preferential rate of as little as 15%; since the aforementioned 1% receive 99% of their income in the form of capital gains, they are enjoying a huge tax advantage in spite of their wealth. If we restore the Clinton-era tax structure and tax long-term capital gains as regular income (short-term capital gains should carry a 5% penalty on top of the long-term rate), the capital gains tax rate for the 1% will jump to 39.6%, yielding a huge windfall for the cause of deficit reduction.

2. Keep the Estate tax intact. There has long been a campaign afoot to eliminate the estate tax, but the fact is that this tax is a big winner for the Federal government. Additionally, there is plenty of evidence that large sums of money that are inherited tend to have a corrosive effect on the next generation, which is why many of the super-rich decide to give away their wealth before they pass on.

3. Enact a 2% National Sales Tax for the express purpose of debt reduction. The simple truth is that there is a huge segment of the population that pays nothing to the Federal government in the form of direct taxes. A 2% sales tax will give everyone skin in the game, including those who pay no income tax.

Of course, if Congress uses this added revenue as an excuse to postpone fiscal discipline, all will be lost.

Therefore, these taxes must be enacted only AFTER significant spending cuts have been enacted. Current expectations are that the budget will be cut by $2T over 10 years, but that is wholly inadequate and will barely budge the needle.

If consensus can be found to reduce federal outlays by $4T over ten years, coupled with sensible entitlement reform and my tax proposals, our country will restore its greatness and the resulting confidence boost will drive productivity gains for decades.

Athens Is Burning

While we watch scenes of street protesters lobbing molotov cocktails at riot police, one begins to wonder how did the world ever imagine that the Greeks would go along with the proposed austerity measures?

Apparently, it was the perception of many, including former Goldman Sachs CEO and Governor of New Jersey, John Corzine, that the wealthy members would bail out the weaker members of the Euro zone.

However, they obviously forgot that European nationals have a long, storied history of disdain for one another, so the idea that they could come together in a caring, sympathetic way to aid a struggling member of their currency union was naive from the start, nor do I think it is a good idea in any event.

The European Union is, above all, a currency union designed to remove currency cost from cross-border transactions, and to aid in payment clearing by a centralized bank.  The EU does not have the kind of authority or control at the Parliamentary level to ensure that member states adhere to fiscally conservative guidelines; the "solution" put forth by France and Germany (major salary cuts, benefits cuts, etc.) is, at best, a suggestion and has no teeth whatsoever.  The only thing that the European Central Bank can do is to stop buying Greek government debt, which will force the default that the austerity proposals are designed to avoid.

Therefore, I view Greek default to be inevitable.  Who suffers the most in the case of Greek default?  Those with significant exposure to Greek sovereign debt, of course, but Greek debt is a drop in the bucket for many  of these creditors, and the IMF and European Central Bank may come to their aid to preserve a portion of their principal in any event.  Of course, the Greeks are headed for a rude awakening when they have trouble borrowing to meet their huge budget shortfall and see the value to their newly minted drakma deposits diminish by 1/3 or more relative to their previous euro valuation.

However, a Greek default will be the best solution for all concerned.  It will put an end to Greece's debt-fueled binge.  In the end the Greeks will benefit in that they can begin putting their fiscal house in order and the investors in Euro Zone debt can finally be disabused of the notion that European sovereign debt is somehow more valuable if the party to the debt is a member of the European Union.

Shaking Up the West Bank

The paradigm that has been the basis of peace negotiations between the Israelis and Palestinians is fundamentally flawed, and Mahmoud Abbas' quest for statehood is shining a bright light on the fundamental corruption of current Israeli policy.

It has long been my opinion that Israel has not been negotiating with the Palestinians in good faith.  The problem that I see is that Israel holds all the cards, and has within its power to annex the West Bank in its entirety tomorrow and grant the people who live there Israeli citizenship (whether they want it or not), effectively putting an end to this charade.  On the other hand, the Palestinians do not have it within their power to define and defend the borders of their proposed nation in a way that could halt Israeli incursion and settlement building.  Therefore, to posit peace based on the premise that the Israelis and Palestinians can negotiate as equal partners is ludicrous.  Asking this today would have been like asking Czechoslovakia to negotiate with Germany over the annexation of the Sudetenland in 1938.

So, it seems clear that each subsequent peace summit is simply an effort to buy time until Israel finally decides what it is they want to do with the occupied territories.  Within Israel there are conflicting camps and the debate is not just between Israel and the rest of the world, but very much between Israelis.  Many Israelis view it as their right, based on biblical history and by virtue of land gained during the 1967 War, to occupy all the land up to the Jordan River.  Other Israelis believe that the Palestinian people, who were expelled from Israel during the 1948 Arab-Israeli War, deserve to have a land to call their own and not live under Israeli occupation.  In the mean time, each subsequent Israeli government has supported settlement building, so the de facto position of the Israeli government is, and has been since 1967, that the West Bank is theirs to do with as they wish.

However, and this is why I say that the Israeli negotiating position is fundamentally corrupt, no Israeli leader that I can recall has ever stated that it is their intent to annex the West Bank and rewrite the map of Israel to extend to the Jordan River, even while their actions say otherwise.

In a speech he delivered to the U.N. General Assembly today, President Obama painted a beautiful picture of how, in light of the "Arab Spring" that has swept across the region, it is now finally time for the Palestinians to taste freedom, but cynically concluded that this could only be possible in the context of an Israeli/Palestinian peace accord.  In other words, Obama recognizes that the current situation is fundamentally immoral and unjust, but that he is not prepared to abandon the corrupt paradigm that has been a cancer and a source of regional tension for decades.

This is why Mahmoud Abbas is going to the U.N. to seek statehood for the occupied territories: he is taking the decisive political action that Israel has failed to do for over forty years.

Could Trade Protectionism Help Stimulate U.S. Manufacturing?

In ordinary times, trade protectionism is inflationary, discourages the efficient allocation of resources, and should be avoided. However, these are not ordinary times we are living in, and extraordinary times call for extraordinary measures.

The picture above is of the discharge from the Three Gorges Dam in China, which symbolizes the huge trade imbalance with China: manufactured goods flow from China to the U.S., but instead of manufactured goods, we are selling them U.S. debt instruments.  When money was cheap and fixed asset prices were rising fast, it made more economic sense to shutter a U.S. factory, sell the land, and ship the equipment off to China to have the goods manufactured and sold back to us cheaper than we could have bought them if we had made them here.  Initially a trickle, this became a huge flood that drained the lifeblood from the U.S. manufacturing sector and has resulted in high unemployment.

This loss of productive capacity has led to a debt crisis in this country that can only be fixed by getting back to what the U.S. has done better than any other country since the Industrial Revolution: MAKE STUFF.  However, bad domestic policies and government-subsidized manufacturing in China have bent the back of U.S. industry to the breaking point.

Therefore, I think we should seriously consider placing additional import tariffs on non-NAFTA goods to give U.S. manufacturers a fighting chance again.  While this could be inflationary in some sectors (those where we have lost almost all productive capacity), the Federal Reserve has proven that inflation is not currently the biggest short-term risk, but rather that deflation and general economic stagnation are bigger dangers. If we can jump-start the domestic manufacturing base, we can create jobs, allow the Federal Reserve and Federal Government to ratchet back their Keynsian stimulus policies and begin to work on a plan to put our country on a sustainable fiscal trajectory.

S&P Gives Uncle Sam a Crewcut

Standard & Poors on Friday cut the credit rating on U.S. Government debt by one notch from the highest tier.

Since S&P (a company founded in 1860) began rating government bonds, U.S. Treasuries have always merited a AAA rating, so the significance of this event cannot be understated.

Some would argue that this was inevitable, that the U.S. will sooner or later have had no option but to default on its debt, but I do not believe this to be true.  I believe that it was the treasonous actions of the Republican Party who, during the recent budget negotiations, allowed the specter of default to become perilously real that prompted this ratings cut.

In other words, the U.S. is now considered less credit-worthy than France, Germany, Sweden, and Canada, of equal credit worthiness to a the communist dictatorship of the People's Republic of China, and one notch above the Italians.

The fact that the United States' fiscal trajectory is on a collision course with ruin is not in doubt.  But, up to this point, the willingness of the U.S. to make good on its obligations, as spelled out in the 14th Amendment to the Constitution, has not been questioned.  It was the Republican leadership in Congress that openly bandied about the threat of default as a political tool, or perhaps because they would indeed like to squander the good faith and credit of the U.S., that caused the rest of the world to start to question our good faith.

So, what will be the impact of S&P credit cut?  Well, that depends in some part upon Moodys and Fitch.  If these two agencies follow suit, as they commonly do, then governments and funds who only hold AAA debt will be forced to sell U.S. Treasuries and buy the bonds of other governments.  The sale of these bonds will depress the price and raise the yield, forcing the Federal Reserve to increase the note rate on new issuance of debt to attract participants to their auctions.

Since, more or less, all interest rates are linked to the rate on the Treasury Notes, rates such at the Prime Rate and the rate of the 30 year mortgage will go up, thereby exacerbating the fiscal condition of our government and of the economy at large.  A higher prime rate will mean that corporate borrowing rates will increase and that more projects will be delayed or cancelled.  Higher mortgage rates will mean that buyers on the margin will be refused loans resulting in more contract cancellations and pressure on equity values. With fewer corporate deals taking place and further declines in equity values bank balance sheets will be under increased strain, possibly resulting in the collapse or downgrade of one or more major banks.  Since the major banks hold each others debt instruments, the collapse of a major bank could put the reserves of numerous banks below the red line, possibly resulting in FDIC seizure in a cascade that would rapidly exhaust available federal insurance funds.

The Federal Reserve would have no alternative but to print money to cover these deposits, which would further devalue the U.S. dollar and result in an up-tick in interest rates (to combat the perceived inflationary pressure to the underlying currency), which would add fuel to this cascade effect.

Working in the favor of the U.S. is the fact that virtually every country in the world, except Canada, Russia and China, are in the same high debt-to-GDP boat. Therefore, it is not so easy to find alternative currencies to the greenback in which to invest.  Additionally, the Chinese need to buy U.S. debt instruments in order to support the peg they maintain on their currency. But, the impacts will be felt nonetheless. Already, Russia and China are piling on their scorn of our profligate ways and it is only a matter of time before this type of talk is followed by posturing.  How this might play out can only be imagined, but the fuse will be set making a diplomatic solution to the next crisis that much harder to achieve.

What do I advise that the average citizen do?  I advise to vote Democrat in November.  We need a monopoly at the Federal level in order to enact the kind of tough measures that need to be enacted to radically alter our fiscal trajectory.  Divided government is useful most of the time, but now is not one of those times (I would argue that we should vote Republican, in spite of my resentment of their role in the credit downgrade, if I thought the Republicans had a serious chance of controlling both houses and the presidency, but I don't see that happening).  Whether the Democrats have the guts to put a means test on Social Security and Medicare, and cut discretionary spending as they must, we can only hope.  But, as long as they can blame the Republicans they won't take the steps needed.

Many people argue that we should be buying gold in times like these, but I view this as being based on a faulty logic, although the recent rise in the bullion would argue that people richer and perhaps smarter than me believe otherwise.  I suspect that their expectation is that we will return to the pre-1972 period in which our currency was backed by a fixed quantity of gold held in Fort Knox (the so-called Gold Standard).  However, it would be counter-productive for the U.S. to unilaterally return to a gold standard if other major currencies failed to follow because we would be surrendering our ability do devalue our debt while our trading partners devalue theirs.  Also, the application of the gold standard would be hugely complicated.  For example, it would require that all gold held in private accounts be surrendered to the U.S. Government in exchange for currency whose value is fixed to the value of gold.  Secondly, it would require that all U.S. currency currently in circulation be replaced with new currency based on the gold standard; since it is estimated that there is more U.S. currency in circulation outside of the U.S. than here at home, this would pose no small problem.

Therefore, I do not believe that we will return to a gold standard.  I hope, however, that we alter our fiscal course expeditiously so as to reduce our debt level to a more manageable level.  Getting there will be hard, and it will be reminiscent of life in the United States in the 1930s, in which huge swaths of the country literally scratched a living out of the land.  It will be a huge, draconian step backward for many, with personal suffering and possibly even hunger as distinct possibilities, but it will ultimately allow our spending to begin to reflect the realities of our financial condition, from which we can rebuild.