William Poole January 11, 2011
William Poole, Senior Economic Adviser, Merk Investments
January 11, 2011
I began writing this note on New Year’s Day; the holiday season is over all too early for me as I contemplate the coming year. Along with other investors, I have many worries, but at the top of my list is the budget battle that will be fought in Washington, every state capital and most capitals of high-income countries abroad. As I finish this note, Republicans are now in charge of the House of Representatives.
The U.S tax battle on the federal level was fought and resolved a few weeks ago, but only temporarily. In early December, President Obama’s Deficit Commission (officially, National Commission on Fiscal Responsibility and Reform) presented its report, with the provocative title “The Moment of Truth.” Unfortunately, the report seems to have dropped out of the news already.
I have read a huge amount of recent press commentary on what lies ahead, but some key issues are missing.
It seems to me naïve to expect significant progress in reducing the long-run federal deficit this year. Jockeying for position ahead of the 2012 Presidential election will explain much of what we are likely to observe. Still, it does not seem too much to ask that our leaders develop broad principles for dealing with the deficit. Why shouldn’t Republican leaders embrace the Deficit Commission’s target of capping federal revenues at 21 percent of GDP? Arguing that spending and revenues should be “lower” without any specifics whatsoever is not responsible governing. Nor is it responsible for Democrats simply to want “more” to fill “unmet” social needs. If 2011 does not see some effort to develop specifics of some sort, then the nation will not make any genuine progress in dealing with the deficit.
It is logical that the House will first defund projects and programs primarily supported by Democratic constituencies. Wind energy subsidies might be an example, as they please environmental groups. However, such programs have already created vested interests, such as companies that build and service wind turbines. Whacking away at such programs will enable Congress to claim progress on reducing spending, but spending reductions will have to reach deep into Republican constituencies as well. Investors in certain industries may be in for some rude shocks.
For investors, failure of the government to make genuine progress will mean increasing peril over time. If the United States cannot begin to address its long-run budget problems—above all reductions in scheduled spending—then the issue for investors will increasingly be when to bail out and what to bail into. Even with a budget stalemate, that macro issue will not arise in 2011.
The 2012 election will be fought over budget successes and failures this year and plans for the future. How those issues are framed will have much to do with how well the winner in 2012 will be able to govern.
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William Poole Senior Economic Adviser Merk Investments, Manager of the Merk Mutual Funds
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