Can the politicians be rational?
July 24, 2011

Untitled Document

In my first newsletter I mentioned the risks of the world economy, especially in Europe and in the United States. In the short run, the Greek crisis is a threat to the European economy because of the effects on other economies and in the long run, it is a threat to the Euro. In the US, the political and ideological differences between the two main political parties put the economy and the international financial system in danger, due to a potential default on treasury payments. What will happen if the safe haven of all crises is not safe anymore?

It took a while for the European leaders to realize that notwithstanding the austerity measures approved by the Greek Congress, their problem would not be resolved, another rescue would be needed and other countries would suffer just as Italy did. Finally, last Thursday, they approved a new rescue combined with some debt restructuring: the maturities were extended from 7.5 years to 15 or even 30 years and the interest rates were reduced from 5.5% to 3.5%. The markets were up on Thursday, but the reality is that the restructuring provides solely around 20% reduction on the debt and much more than that would be necessary to make it possible for Greece to comply with payments.

The United States is in a completely different place, although some analysts, mostly conservatives, keep insisting that we are as broke as Greece is. The fact of the matter is that the US produces more than just olive oil and tourism; its economy is not broken, and the source of its problems is political rather than fiscal. The deficit is a small percentage of GDP. Do not misunderstand me; I am not defending deficits or fiscal irresponsibility, but quite the opposite. That is precisely why the Republicans irritated me so much: the last Republican government was fiscally irresponsible and the debt ceiling was raised 9 times. Yes, the US has a deficit, but it can be solved with a little rationality in the debate and a combination of spending cuts and revenue increase. However, Congress is not discussing that. It is more like a Babel tower, with the democrats digging their feet on the 3 pillars of the welfare state, Medicare, Medicaid and Social Security and on the other side, the Republicans with the Tea Party leading the crowd, opposing any increase on tax or the end of some subsidies.

I have been following the debate in the last few months and I just realized that I was wasting my time. I cannot fathom how someone could assert that tax cuts solve the deficits and create jobs, when any high school student who learned the basics of economics knows this to be false. Finally I understood; it is not about the deficit! The only goal of the republicans is to be sure that Obama is a one-term President. The underlying motive of questioning his citizenship and his religion is to question his legitimacy. They just do not accept a Democrat President, let alone a black Democrat President. Destroying Obama is the true goal and if the economy and jobs are going to be destroyed, so be it. It took me a while, but I got it.

I think that the debt ceiling will be increased at the eleventh hour or even this weekend. That will occur one way or the other. Something's got to give. President Obama is not suicidal, I think. Meaning, he would not accept a deal that only included cuts on expenses, because you don't do that with the economy already struggling. A reduction on expenses would be a drag in an economy that already faces sub-par growth. It could cause it to lose another 0.5%. That is why I don't believe in that kind of deal: signing that would be equivalent accepting that he would not be reelected, because he would start 2012 with 1.5% growth and close to 10% unemployment.

I think it is time for the White House to clarify that the debt ceiling has to be increased because it only reflects expenses and decisions already made, in the past. It could also take the opportunity to teach a lesson about choices. For instance, if there is no raise in the debt ceiling, the treasury will start to make choices on who will receive the money that is left. For instance, what comes first, interest payments for the Chinese or for the troops on the ground? Should we pay doctors and hospitals or the immigration agents? I vote for doctors as it would be great to have no lines arriving in the US and go straight to the baggage claim. Even more interesting would be the choice about federal prisons: should we just release all the prisoners? What about the board? The Mexicans could finally come to the USA without being arrested. Oh by the way, say good bye to French wine and cheese because without customs there are no imports.

While the Congress discusses how to destroy the economy, the earnings seasons is showing that corporate America is doing well, thank you very much, mostly driven by business abroad. As a result the markets have been very volatile: some days the good news from the companies overcomes the bad news and the market goes up, other days Congress and Europe make the market go down. If you have the heart to ignore the news and remain focused on the long term, in a world where AAPLE, IBM ,Coca Cola and Nestle will still be around and hopefully Eric Cantor and John Boehner will not, just sit tight. If you don't have the heart, do as Soros did and be 75% in cash waiting to see how it is going to play out.

I will finish with a wise man's words:

"Unfortunately, Congress consistently brings the Government to the edge of default before facing its responsibility. This brinkmanship threatens the holders of government bonds and those who rely on Social Security and veterans benefits. Interest rates would skyrocket, instability would occur in financial markets, and the Federal deficit would soar. The United States has a special responsibility to itself and the world to meet its obligations. It means we have a well-earned reputation for reliability and credibility-two things that set us apart from much of the world." Reagan, Sept 1987

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