President Bush’s new (and DOA at the House) $3.1 trillion dollar budget projects that, by September 30, 2008 — the end of the current Federal fiscal year — the shortfall over revenues will be $410 billion. The House majority party is salivating over the choice chops of political fodder this provides in an election year, while at the same time patting themselves on the back for delivering a $150 billion stimulus package to the economy, which does nothing to stimulate the economy. Because this stimulus spending is short term, the package outlay translates dollar for dollar directly to the deficit. (To be fair, the President has signed off on this package also in the spirit of true bipartisanship — lookout taxpayer!)

I consider myself somewhat prudent in that while I have a mortgage, the P&I seldom exceeds $1000 a month (it’s an ARM and thus varies with LIBOR); I don’t have any outstanding credit card debt — I am a transactor rather than a revolver; and I have some investments and savings.

The Federal Reserve has reduced interest rates in the last few months by almost 2 points. This is to bolster the economy (as perceived through the lens of the equities and bond markets). The markets have rallied, and then sunk as the impact is absorbed and evaluated. Democrats in Congress are talking about not being able to ‘afford extending the Bush tax cuts‘ and not being able to ‘afford the revocation of the AMT‘. They are also talking about expanding many programs.

What does this all mean to me?

My ARM resets every February based on the preceding six months LIBOR so the reduction of the Fed rate is likely to have little impact on my P&I. Additionally, since the LIBOR has lately decoupled from the Fed rate there is no guarantee that any Fed action will lower LIBOR. Credit card issuers adjust their loan rates monthly, usually based on 10-12% over the Fed rate, so that they can maintain a good net interest margin. However, since I am prudent and have no revolving card debt, I obtain no benefit from this. Since the rate goes down, so does the interest accrued to my meager savings and money market accounts. Current savings rates are less than the CPI so in terms of dollar denominated spending power, the value of my savings actually decreases.

One effect of the cuts manifests in the dollar’s value compared with other currencies. The dollar has achieved new lows. As a result, dollar denominated commodities such as oil and grain, have increased in terms of price. The value of a barrel of oil is the same or slightly rising (due to demand) but the value of the dollar is falling meaning that you need more of them to buy that barrel. Consequently, gasoline is hovering near $3.00 per gallon and can only rise as demand picks up again. Consequence to me: I have to pay more to get to work and back to buy fuel. I have to spend more of my pay to keep my house heated in the winter and to pay for electricity.

Policy decisions in Congress, particularly with the ethanol alternative fuel initiative, have also had their effect. These efforts are a derivative effect to mitigate the higher oil prices. Subsidies to ethanol producers — again an expense supported by taxes — have driven corn prices higher. Basic grain products have increased in price, cattle feed and thus meat has increased in price, and since corn syrup is used in about everything, most other processed foods have increased in price. Consequences to me: inflation.

One of the reasons that is used to support the package is that the liquidity of the financial markets is being reduced. The reason for that is simple — bankers don’t have a good feel anymore for what an asset is worth, and consequently are reluctant to lend money against that asset. Multiple levels of risk diversification haven’t quite worked out as planned. While I am a fan of and support securitization, the packaging of asset and mortgage backed securities with credit enhancements and credit default swaps constituted building a house of cards. Young financial engineers with little experience in the downside of things spun up an edifice of risk that is still in the process of toppling. But the Fed has already provided an answer to the liquidity problem through its discount window where banks are assured of obtaining the capital they need. The stimulus package doesn’t affect this. By viewing the economy entirely through the lens of the financial market, rate cuts only reinforces risky behavior. The Fed action is predicated on the premise (unsubstantiated) that whatever affects the markets eventually affects the general economy.

Finally, it seems as if Congress doesn’t learn anything. If anything was clearly demonstrated by the Bush tax cuts, it was Laffer’s theorem that there is an optimum taxation rate to provide maximum revenue. Since the stimulus package will increase the deficit, the inevitable result will be a call for an increase in taxes. The result of that will be a slowdown of the economy, a decrease in tax revenue, which will result is still higher deficits. Plus, the effect will flow down to the States and their revenue streams. All of the ‘good’ and ‘beneficial’ programs will be strained and States and Cities will attempt to make up the shortfall. Consequence to me: My take-home pay decreases as my fed taxes increase. My property tax component which is now slightly less than my P&I amount will exceed it and I will absorb more of the burden of government.

The reason that the market has blipped higher and then reset is that investors collectively know these things. This non-stimulus stimulus package offers no long term market or economic benefit. This package and the rate cut itself is a profligate renunciation of fiscal prudence. The current set of policies rewards the behavior the current Congress rails about: the lack of savings of US citizens; an excessive burden of credit card debt; highly leveraged mortgages; overreliance on oil.

Here is my table of consequences:

Result/Effect Prudent Man Profligate Consumer
Gasoline Prices Screwed Screwed
Leveraged Mortgage Not Applicable Bailout
Savings Reduced Value Say What?
Food Prices Higher Higher
Credit Card Payments No Effect Lower
Risky Financial Behavior No Effect Rewarded
Income Taxes Increased Likely Exempt
Property Taxes Increased Dude! I rent.

So!

Never one to bitch without offering a solution, here is what we need to do:

  • Actually limit federal and state spending. Cut agency staff and eliminate costly programs which do not perform. Insure each agency has a performance metric upon which future funding is based.
  • Stop adding new entitlement classes to existing entitlements of Medicare and Social Security. Take a close look at the implementation to insure that the program is not driving UP the cost of health care.
  • Eliminate tax deductions on corporate contributions for employee health care.
  • Increase the Fed Rate by 3 full points. The market will take a dive. So the next day …
  • Announce the elimination of the AMT (and follow through) and make a permanent tax rate of 10% ($20,000 < Income < $250,000) and 22% (Income > $250,000).
  • Completely eliminate capital gains tax.
  • Eliminate corporate income tax. (This is just another tax on the consumer , since it’s passed through).

Basically, fix the tax problem and all other problems will fall into line. There is a reason why formerly Communist countries have gone to flat taxes and low rates.

Advertisements