Thursday, August 4, 2011

Crises all around

Just briefly wanted to address the ways in which developed economies look to be heading off a cliff. First, while a debt ceiling deal was reached in the US, the package won't help our debt levels going forward. There are several reasons for this. One, spending cuts made up most of the deal, which will hurt the economy, whereas the best way to get out of debt is to grow the economy (see the 1990s for an example). Second, nothing was done to address long-term entitlements, the main source of our coming (but NOT CURRENT debt problem). Third, tax increases weren't on the table (Republicans were even against closing tax loopholes, because it would increase revenue). While tax increases now wouldn't help the economy, obviously, they will have to occur if we're to pay for the large number of baby boomers about to retire and get our budget eventually to balance. The party that disagrees is in denial. Despite what you've heard, overall tax (i.e., revenue) collection is currently at its lowest level in decades. That's part of the reason why the budget deficit is so high (i.e., it's not just that the government is spending tons of money). None of this was solved with the recent debt deal. In fact, looking at the markets the last few days (see figure), their outlook has grown quite dim.

This is exacerbated by what's going on in Europe. Countries such as Greece, Ireland, and Portugal have been on the brink for months. Recently, Italy and Spain have seen their borrowing costs soar due to a loss of market confidence. It's a death spiral as higher borrowing costs will make it even harder on their finances. While Germany could bail out Greece, it has little hope of being able to afford the same for huge Italy and Spain... and the leaders there seem to be content to watch their continent burn while they're on holiday. The Euro could very well come undone and we could be seeing years of stagnation. The sad thing is that better decision-making could have helped prevent this.

To bring this home, however, remember the words of Baron Rothschild, an 18th century British nobleman, who said the best time to buy (stocks, whether individually, through a mutual fund or 401(k)) is when there's blood in the streets.

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