Bruce Glensky | Fiscal cliff resolution shifts burden of discipline to creditors

January 5, 2013 

The fiscal cliff was created by Congress to force decision-making. The process of sequestration; across the board spending reductions on defense and discretionary spending, and the expiration of the Bush and Obama tax-cuts would force the “grand bargain” that would yield a ratio of spending cuts to tax increases of 4 to 1. The grand bargain would sustain short-term economic growth while putting the budget deficit on a long-term path toward balance. This vision fell apart on New Year’s Day.

Sequestration was deferred with moderate Republicans, like Senator John McCain (R-Ariz.) voting to forgo what he viewed as Draconian defense cuts. High fives were ubiquitous among Democrats and Republicans alike for “making permanent” the middle class tax cuts for 98 percent of taxpayers. The result is unsustainable, therefore making permanent is a fallacy.

The deficit is the gap between the government that people want and the one they are willing to pay for. The grand bargain would have narrowed that gap. Unfortunately, Congress and the President caved, and the public is now under the impression that this anomaly of economic nature can continue to exist. It cannot.

The stock market responded favorably to kicking the can of fiscal discipline down the road because investors perceive that we have avoided an immediate recession. The sugar high of monetary and fiscal laxity will continue until we hit the wall of ultimate resistance.

The sausage is inferior and the making was distasteful. Before the negotiations in the Senate were complete, President Obama took the stage with “middle class” Americans for a premature celebration, almost spoiling the well of compromise before the compromise was reached. South Carolina Sen. Lindsey Graham responded to the president: “This president thinks small things.” If by small he means not comprehensive, he is on the mark. In his position statement, Graham encouraged Republicans in the House to vote yes, while pledging Senate support to fix the spending side of the issue through the debt limitation negotiations.

To get to this point, Congress and the administration have avoided the normal checks and balances. The free press should have forced a more complete airing of legislative differences during the campaign. They did not. Our press today chooses sides and advances their own candidates, rather than thoughtfully and thoroughly cross examining candidate positions. The term fiscal cliff was seldom heard during the election campaign but could not be avoided thereafter.

Creditors, the debt markets, are a second level of checks and balances. Interest rates should be elevated to force financial prudency. Why have interest rates remained low? Because China reinvested its trade surpluses in U.S. Treasury obligations for both safety and currency manipulation, and the Federal Reserve has bought 70 percent of new issuance through debt monetization. The market is so artificial that it cannot impose the necessary discipline. Said differently, the free market cannot enforce an outcome because there is no free market. The debt limit, therefore, becomes the only tangible. Perversely, it may require that politicians impose a check and balance on the bond market through resisting increases in the debt limit to wake the market up to the risks that we face.

Former Vermont Gov. Howard Dean wanted to go over the fiscal cliff because he believed that more tax increases will be necessary for fiscal balance. He has correctly assessed the long-term problem. In an interview on Fox News he said the following: “Health care cost is the problem in general and Medicare is the problem in the specific.” The fall elections left the public with the perception that no one over the age of 54 would bear the burden of the Medicare adjustments. The average retiree today receives $3 of health care benefits for every dollar of Medicare related taxes paid into the program. This is a Boomer’s problem. We need to change the way we consume healthcare and the medical and insurance industries must change the way it is delivered and financed.

The pace of economic recovery has been weak. We face many hurdles before we can stabilize the economy and put it on a foundation for sustainable growth.

The burden of this period of subpar growth is being carried by savers, recent college graduates and the long-term under-employed. We have made little progress in resolving the debt imbalances from the crisis of 2008. Our standard of living will not improve until the free market is brought to function in areas where it is currently prohibited: healthcare, finance, energy and education. The fiscal deficits cannot improve until entitlement spending is contained and the largest issue here by far is Medicare. It is the latter point that we are likely to deal with first.

Envision the president pleading for the middle class surrounded by senior citizens. This vision is not a far stretch from that which actually happened on New Year’s Eve. CNBC has been interviewing politicians and handing out buttons to “rise above” the pettiness of partisanship. This cannot be done unless the behavior of the President rises above that of a community organizer. Leadership is required. Unlike the members of the AARP, creditors are faceless and half of them are foreign.

We are badly in need of budgetary discipline that only a shock appears able to bring. The period leading up to the debt limitation extension will be politically and financially rocky and that is one deadline for a grand bargain that the politicians may be willing to impose.

Contact Glensky , a former Wall Street financial manager who now lives in North Myrtle Beach, at bwglensky@sccoast.net.

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