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US: The Crisis Games

January 21, 2013 08:16

This American fiscal issue is first of all going to mean crisis after crisis if the Republicans are serious at all about the deficit. Will they blink, or will they allow the government to shut down? It was shut down twice in the 1990s. The world survived.

By John Mauldin

In my opinion 2013 is a make or break year for the US. If we are going to get the deficit on a glide path to balance, then it needs to happen this year. (I should note I have been saying 2013 since 2010.) 2014 is an election year, and it will be muy difícil to get anything of substance done then. Will Obama be any more willing to compromise in 2015? At that point I think it is too late and the bond market, having watched Japan and France and much of Europe descend into chaos, will simply begin to demand higher rates, no matter what the Fed does. If it doesn’t happen even sooner.

This American fiscal issue is first of all going to mean crisis after crisis if the Republicans are serious at all about the deficit. Will they blink, or will they allow the government to shut down? It was shut down twice in the 1990s. The world survived. I wish we had a more collegial system. Who knew we would be nostalgic for the era of Clinton and Gingrich?

Again, this letter is getting long and we all know the problems. I will write more on all this in future letters. But before we leave the issue, let me offer a suggestion to House Republicans and some thoughts on the unsustainability of entitlements.

First, let me humbly suggest that the House pass two budgets. Not one, two. First, pass one that assumes that current tax policy remains intact, but that puts us on a glide path to a balanced budget in seven years. Then pass one with the same goal but with sweeping, pro-growth tax reform. Like a 15% corporate tax but no deductions for anything. Total elimination of tax expenditures. Maybe get crazy and substitute a VAT for the Social Security tax. No halfway measures. Get radical.

Then send both budgets to the Senate with a note that says you will be glad to vote to extend the debt ceiling for a period of time, when they pass a budget the president will sign. After all, they have 55 Democratic senators. They do control the Senate. They have not passed a constitutionally mandated budget for three years. What’s to think they can pass anything? Stop negotiating with yourselves and make them put something on the table that the president publicly agrees with.

The debt ceiling then becomes the problem of the Senate and the president. They can get an increase any time they pass a budget that they can find just five Republicans to vote for. It doesn’t have to be one of your two options, but it does have to be something that is public. The Senate is supposed to be where compromises happen. So let them compromise, and then and only then sit down to talk.

In the meantime pass true immigration reform. Go the extra mile on this one. It is good policy and good politics. Pass any House Democratic proposal that makes even a little sense. Show some true bipartisanship. And no negotiating on the budget until the Senate passes a bill that Obama will sign. Then get serious and get it done.

A few final thoughts on the US. The tax increases are going to add up to more than advertised in the mainstream media, perhaps as much as 1.5% of GDP. This is not going to make for a robust first half. A quarter or two of outright recession is quite possible. At the least, growth will be very weak. And the hidden tax of increased healthcare insurance costs as a result of “Obamacare” will be more than 1% in the latter half of 2013, as insurance companies adjust to rising mandates and costs in 2014. Insurance companies are announcing major increases in premiums. My own company healthcare costs are up an eye-shocking amount. And for labor-intensive businesses? Workers are going to be left to the tender mercies of the new healthcare system.

Obamacare is going to be the mother of all bureaucratic nightmares to implement. I am in sympathy with the need for change in the healthcare system, but how we think we can radically adjust 15% of the US economy with no collateral damage to it is beyond me. On top of the tax increases, Obamacare will mean a very lackluster year for the US economy.

Entitlement Unsustainability

One of the things foremost in my mind is the unsustainability of entitlements, especially healthcare. We all know that Social Security can be resolved rather quickly, but healthcare is going to be difficult. Not the least of the problems is that Americans live manifestly unhealthy lifestyles. Data suggests we are actually 40% sicker than our European counterparts, which explains why healthcare costs so much more here in terms of GDP. Further, healthcare policy was formed in an era of big business and labor unions, and that time is passing.

As I was discussing this with Pat Cox tonight, he mentioned that Michael Barone used nearly those exact words in his op-ed today. I stopped and read it and found myself nodding in agreement. He noted a repeating 76-year cycle in American politics (only modestly forced) that suggests a new era is upon us. Not too far off from Neil Howe’s Generations cyclical thesis. You can read the whole column here. Let me quote from the ending:

“The original arrangements in each 76-year period became unworkable and unraveled toward its end. Eighteenth-century Americans rejected the Colonial status quo and launched a revolution, then established a constitutional republic.

Nineteenth-century Americans went to war over expansion of slavery. Early-20th-century Americans grappled with the collapse of the private-sector economy in the Depression of the 1930s.We are seeing something like this again today. The welfare state arrangements that once seemed solid are on the path to unsustainability.

Entitlement programs – Social Security, Medicare, Medicaid – are threatening to gobble up the whole government and much of the private sector, as well. Lifetime employment by one big company represented by one big union is a thing of the past. People who counted on corporate or public-sector pensions are seeing them default.

Looking back, we are as far away in time today from victory in World War II in 1945 as Americans were at the time of the Dred Scott decision from the First Inaugural. We are as far away in time today from passage of the Social Security in 1935 as Americans then were from the launching of post-Civil War Reconstruction.

Nevertheless our current president and most politicians of his party seem determined to continue the current welfare state arrangements – historian Walter Russell Mead calls this the blue-state model – into the indefinite future.

Some leaders of the other party are advancing ideas for adapting a system that worked reasonably well in an industrial age dominated by seemingly eternal big units into something that can prove workable in an information age experiencing continual change and upheaval wrought by innovations in the market economy.

The current 76-year period is nearing its end. What will come next?”

I can see multiple paths, but all must inevitably lead to some form of sustainability. Avoid the rush. Go ahead and begin adapting now!

By the end of this decade and probably much sooner we will have transformed the unsustainable current system into something more manageable. The secular bear market will have ended. Healthcare and medicine are due for a radical upgrade, and science-fiction-like technologies await.

The new era (I am searching for a name to call it) will be most welcome if you make plans to transition from where we are to where we are going. And this letter will chronicle the journey. Stay with me. For those of you who are interested in alternative investments to address the kinds of challenges we’ve covered here, I’ve written a piece on the global macro environment, which you can access at http://www.altegris.com/MauldinGlobalMacro. (In this regard I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

John Mauldin
John@FrontlineThoughts.com

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