Obama Claims We Don’t Have A Spending Problem

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 15, 2013

IN THIS ISSUE:

1. Yes, Mr. President, There Is A Spending Problem!

2. Lots of Disgusting Pork In The Fiscal Cliff Bill

3. Another Debt Ceiling Battle Looms In February

4. Obama Could Resort To The 14^th Amendment

5. The Trillion Dollar Coin – Haven’t Heard About This?

6. “Continuing Resolution” To Fund The Government

Overview

There’s a lot to talk about this week. A lot of my contemporaries are offering their predictions for the New Year. But with our nation now over $16 trillion in debt and annual budget deficits over $1 trillion, I don’t think there is any way to accurately predict what will happen this year. Another financial crisis could rear its ugly head just about any time.

Most of the forecasters I subscribe to expect economic growth to average only 1-2% in the first half of 2013. Most believe that 4Q GDP fell sharply from the 3.1% rate in the 3Q of last year, largely due to fears about the fiscal cliff. They also expect growth to improve modestly in the second half of this year to 2% or slightly higher. That’s not too optimistic.

One reason is that the end of the payroll tax holiday on December 31 means that workers’ pay went down by 2% on January 1, thus adding more headwinds to the economy this year. A person earning $50,000 a year before taxes, for example, will pay an additional $1,000 or more to the government this year.

Add to that the fact that we are sure to have another nasty debt ceiling battle next month, which will once again be unsettling to consumers who drive the economy. We all remember the fiasco in the summer of 2011 when the Dow plunged over 2,000 points. For these reasons and others, at least the first half of 2013 could be very dicey.

Actually there are three debt battles – the so called “trifecta” – that lie ahead. In addition to the debt ceiling battle, there is also the sequester/automatic spending cuts on March 1 and the “continuing resolution” to fund the government in the absence of a formal budget passed by Congress. That happens in late March. We will look at all three of these upcoming battles below.

Today we’ll also touch on the pork-laden fiscal cliff bill that passed on New Year’s Day. And we will ponder the question of whether the US has a “spending problem” or a “taxing problem.” Let’s start with this last one first.

Yes, Mr. President, There Is A Spending Problem!

You may recall that during the recent fiscal cliff negotiations, President Obama and House Speaker Boehner met at the White House with the hope of agreeing to some kind of budget deal. That meeting flopped. Afterward, Speaker Boehner reported that at one point Obama told him that the US does not have a “spending problem.”

You’re probably thinking: How could the president possibly say that? After all, Obama’s own Debt Commission stated clearly in its final report that the US has a serious spending problem that is the driving force behind the nation’s debt crisis. Here’s what the report said:

"Even after the economy recovers, federal spending is projected to increase faster than revenues, so the government will have to continue borrowing money to spend. Over the long run, as the baby boomers retire and health care costs continue to grow, the situation will become far worse. We should cut all excess spending — including defense, domestic programs, entitlement spending, and spending in the tax code.”

Federal receipts/outlays in 2005 U.S. dollars

The Commission was hardly breaking new ground here. Indeed, anyone who has looked at the explosion of the national debt in recent years can quickly see that out-of-control spending, not insufficient revenues, is the main problem. As the chart shows, even with the $620 billion in tax hikes Obama won during the fiscal cliff fight, plus the $500 billion in new ObamaCare taxes starting this year, spending will continue to outstrip revenues as far as the eye can see.

By 2022, federal revenues will top 19% of GDP, which is significantly higher than the post-World War II average. But spending will exceed 22%, and keep climbing. Meanwhile, the Government Accountability Office (GAO) report concluded that spending is "on an unsustainable long-term fiscal path" and blamed entitlements.

And countless Congressional Budget Office reports have documented how, if left unchecked, federal entitlement program spending and the interest on our debt will soon swamp the entire budget. So in addition to not reading his own his Debt Commission report, apparently Obama didn't read any of the other reports noted above either.

Just after his big victory on the fiscal cliff bill, the president warned that higher income Americans are going to get even more tax increases just ahead. Just when the Republicans thought the tax battle was settled, Obama, Harry Reid and Nancy Pelosi threatened even more big tax increases on “the rich” – that is, families making over $250,000 a year. This time, they’ll probably go after popular tax deductions such as home mortgage interest, charitable giving, etc. Another tax battle is coming, count on it!

Lots of Disgusting Pork In The Fiscal Cliff Bill

You’d think that Congress would have kept the fiscal cliff negotiations as simple and tight as possible. The size of the deficit, the threat of automatic spending cuts, and the need for a last-minute tax deal deserved everyone’s full attention. And yet, the Congressional Budget Office breakdown of the bill shows that there were all sorts of pork buried in the fine print, benefiting everyone from filmmakers to rum distillers.

The problem is so-called “tax expenditures,” which are basically ways to subsidize various kinds of activities through tax breaks (as opposed to direct payments). The fiscal cliff deal consists of three parts – personal taxes, business taxes and energy taxes – and each includes its own giveaways. Many of these were simply increases or extensions of tax expenditures that already existed. But why were they snuck in as part of the fiscal cliff bill?

Here are just some examples of the beneficiaries of the pork that was in the fiscal cliff deal:

Motorsport Racetrack	Movies & TV
Native Americans	Caribbean Islands
Foreign Investors	Puerto Rico & Samoa
Electric Motorcycles	Biodiesel/Other Green Fuels
Algae Fuel	Asparagus

All told, the fiscal cliff law designed to reduce the deficit, added $74 billion in new spending and tax expenditures.

Sadly, most Americans don’t know about any of this. Most of the pork mentioned above was snuck into the fiscal cliff bill in the Senate. With the December 31 deadline already eclipsed, enough Republicans in the House felt they had no choice but to vote for the bill on New Year’s Day. This is really discouraging! No, disgusting!!

Unfortunately, the $51 billion Hurricane Sandy relief bill now making its way through Congress is also loaded with pork. Of the $51 billion in the bill, reportedly almost half of that money is “earmarked” for new federal spending – complete with a list of all the federal agencies that will receive new money – under the guise of Sandy relief. This, too, is really disgusting!

Finally, even if Obama did understand the magnitude of the spending crisis, it’s doubtful that Congress would deliver a solution. The shameless game of “if you scratch my back, I’ll scratch yours” essentially precludes a reasonable solution to this problem. No wonder congressional approval ratings are near all-time lows!

Congress Job Approval

Another Debt Ceiling Battle Looms in February

On Dec. 31, 2012, the US officially hit its current authorized borrowing limit – also known as the debt ceiling – of about $16.4 trillion. Treasury Secretary Geithner informed Congress in late December that he will be able to avoid breaching the limit through “extraordinary measures,’' but only for a couple of months at best.

This sets up a renewal of the conflict in 2011 that brought the country within days of default and led to the first ever downgrading of the federal government’s credit rating. Congressional Republicans insist that they will continue to demand, as they did in 2011, that any increase in the debt limit be tied to significant spending cuts. But President Obama has said that this time he will not negotiate over the debt limit. On New Year’s Day, he threatened:

“I will not have another debate with this Congress over whether or not they should pay the bills that they’ve already racked up through the laws that they passed… If Congress refuses to give the United States government the ability to pay these bills on time, the consequences for the entire global economy would be catastrophic – far worse than the impact of a fiscal cliff.”

The president’s position appeals to his liberal allies, who fear another round of compromises by Mr. Obama. But it once again sets the stage for a nail-biting standoff that economists warn could lead to a damaging financial default and doubt from investors about the ability of the country to pay its obligations.

Credit rating agencies like Moody’s and Standard & Poor’s have warned that the looming debt ceiling battle could result in even further downgrades to the nation’s credit rating. But the financial imperative for an increase in the debt limit comes at a time of increasingly sour relations between the president and his Republican adversaries in the House.

A spokesman for House Speaker Boehner confirmed that his heels are equally dug in:

“The speaker told the president to his face that everything you want in life comes with a price. That doesn’t change here.”

So, the stage is set for another gut-wrenching political battle that should be in full swing by the middle of February when some believe that the extraordinary measures by the Treasury to keep the government afloat could be exhausted. This will almost certainly not be good for the stock markets. The Dow plunged over 2,000 points in 2011 during the debt ceiling battle.

Given that President Obama has vowed not to negotiate ever again on the debt limit, he may decide to go on a road trip, using the “bully pulpit” in an effort to convince the public that another fight over the debt ceiling risks another economic crisis. Public polls after the last debt ceiling fight suggested that most people blamed Republicans for the threat of a shutdown.

Obama Could Resort to the 14^th Amendment

Since President Obama has vowed that he will not play the “debt ceiling game” with the Republicans anymore, many on the left are arguing (once again) that he should bypass the Congress altogether and unilaterally raise the debt limit based on provisions in the 14^th Amendment to the US Constitution.

The 14^th Amendment, which was adopted in July 1868, was meant to ensure the payment of Union debts after the Civil War and to disavow Confederate ones. But it was written in broader terms: “The validity of the public debt of the United States, authorized by law, including debts incurred for payments of pensions and bounties for services in suppressing insurrection or rebellion shall not be questioned.”

Some have suggested that a sitting president could invoke this passage of the 14^th Amendment to unilaterally increase the debt ceiling without Congressional approval. It has been considered often in the past, but no president has ever actually done so. The Supreme Court has never formally ruled on this question, but has indicated that this law was clearly intended for the post-Civil War period and is not relative to the present day.

Fortunately, White House press secretary Jay Carney has said that President Obama has no plans to unilaterally raise the current debt ceiling based on the 14^th Amendment.

The Trillion Dollar Coin – Haven’t Heard About This?

The 14^th Amendment also includes provisions which allow the US government to mint new coins to pay for its debts under certain conditions. While there are more current laws in place to regulate how much paper, gold, silver or copper currency can be minted and circulated by the government, there is nothing so clearly stated when it comes to platinum.

The Commemorative Coin Authorization and Reform Act of 1995 allows the government to issue platinum coins in any denomination it chooses. The law says the Treasury Secretary "may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time."

The idea was that a Treasury Secretary might authorize the creation of a commemorative eagle coin, for instance, to be put on sale for collectors. But the law inadvertently gave the Treasury Secretary more broad authority when it comes to minting new coins, especially platinum coins.

The idea to mint new platinum coins, presumably in large denominations, has received a lot of attention since President Obama vowed recently that he would not engage in further negotiations with Congress over the debt limit and would bypass lawmakers entirely if necessary. This has spawned serious discussions on how far the president might go in bypassing Congress.

At one point last week, the Obama administration felt obligated to respond. White House Press Secretary Jay Carney said, “There is no Plan B, there is no backup plan. There is Congress’s responsibility to pay the bills of the United States,” responding to questions about the trillion-dollar coin at a news conference.

But Mr. Carney did not initially rule the idea out explicitly, deferring later questions to the Treasury Department. That left a few supporters hoping that in one of his last acts in office, Treasury Secretary Tim Geithner might trot out a shiny platinum coin emblazoned with “In God We Trust” and a 1 with 12 zeros behind it.

The idea here would come from exploiting a 1997 law, as noted above, that allows the Treasury to “mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, the power to mint, say, a $1 trillion coin, or even a $5 trillion coin.” [Emphasis added]

Believe it or not, some on the left – including Nobel Prize winning economist Paul Krugman – are arguing that President Obama should authorize the minting of $1 Trillion platinum coins as a way to deal with our exploding debt. Here’s how it would work in theory.

Assuming Congress won’t approve raising the debt ceiling, the Treasury could begin minting new platinum coins that would be handed over to the Federal Reserve, which would use the new coins as collateral for making large new loans to the government to pay its bills. As noted above, there is even talk of minting single new platinum coins with a face value of $1 Trillion. I kid you not!

I seriously doubt that this will happen. But the fact that it is being talked about in serious circles is alarming. Don’t believe me? Just Google “trillion dollar coin” and see what you find. You’ll be surprised!

Continuing Resolution To Fund The Government

As you probably know, the Senate has not passed a federal budget, as required by law, in over three years. In the absence of a budget, Congress funds the government by way of a “Continuing Resolution.” If a formal appropriations bill (budget) has not been signed into law by the end of the fiscal year, Congress is called upon to pass a joint resolution to continue funding federal programs at current or reduced levels.

Continuing resolutions have been used for more than 135 years. In only four cases since 1975 has Congress passed all appropriation bills before the beginning of the new fiscal year. On September 28 of last year, President Obama signed into law a continuing resolution to fund the government for six months. That resolution ends on March 27 when yet another budget dilemma will unfold.

Standoffs between the president and Congress or between political parties complicate the budget process, frequently making the continuing resolution a common occurrence in American government. Federal agencies, including the military, are disrupted by the periods of reduced funding. With non-essential operations often suspended, many agencies are forced to interrupt research projects, training programs or other important functions.

Conclusions – What To Do Now

So, in addition to the debt ceiling battle next month and the sequester/automatic spending cuts on March 1, we have the threat of another continuing resolution fight before the end of March. This can’t be good for the investment markets!

The US credit rating was downgraded for the first time ever in 2011 as the debt ceiling battle played out. The rating agencies are already threatening a further downgrade this time around. Again, this can’t be good for the investment markets.

As noted earlier, the Dow Jones plunged over 2,000 points in the summer of 2011 when the last debt ceiling battle unfolded and the government faced a shutdown. The S&P 500 Index lost over 16% of its value in May – September of 2011 as the debt ceiling battle played out. Could it happen again? You bet!

But next week, I’ll show you an alternative way to position part of your portfolio into a strategy that actually gained over 17% in May – September of 2011 during the debt ceiling battle and finished the year 2011 with a net gain of 18.9%. This same strategy has gained an average of 19.9% over the last five years, with a worst losing period (drawdown) of only 12.9%.

As always, past performance is not necessarily indicative of future results.

Sound interesting? I thought so. Be sure to read next week’s E-Letter.

If you don’t want to wait, call one of our Investment Consultants at 800-348-3601.

Best New Year’s wishes,

Gary D. Halbert

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