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Debt Deal, Our ‘Walking Pneumonia’ Economy, QE3 and More ‘Sense on Cents’

Posted by Larry Doyle on August 1, 2011 7:40 AM |

What now? What lies ahead on the challenging and winding road filled with clouds and great unknowns that defines our American economic landscape?

The political circus in Washington has clearly taken center stage over the last few weeks. Watching this show has been anything but entertaining and don’t think the theatrics do not harm our economy. They do.

Uncertainty breeds risk aversion and our economy needs people and businesses willing to take risks.

Can we assume that the passage of a bipartisan debt package means we can get back to business as usual and that the economy will rebound? Not so fast.

Business as we know it has been anything but usual over the last few years and will be anything but usual in the years ahead. In fact, in the near term I am fairly certain that this debt package will actually negatively impact our ‘walking pneumonia’ economy.

Our economy has not been overly robust in 2011 to this point. 1st quarter GDP was recently revised to a barely positive .4% while 2nd quarter GDP registered a less than robust 1.3%. Revisions to prior quarters received little to no attention but were also revised lower, in some cases substantially.

I read those revisions as an indication that our economy has not been recovering nearly as much as the circus performers and their sidekicks might have had us believe. Cooking the books? Playing with the numbers? No doubt but those are tales for another day.

I have long described our economy as suffering from ‘walking pneumonia’ and I believe that shortness of breath will only worsen over the next 6-18 months. In fact, Barclays just this morning revised their 2011 and 2012 GDP forecasts lower by approximately 25-30%.  That reality is a reflection that our ‘walking pneumonia’ economy will not only be with us for a protracted period but our condition will not soon improve.

I believe that Barack Obama and incumbents in both parties should be seriously concerned about their prospects in the 2012 election.

The debt deal certainly has many chapters yet to be written but as currently laid out it will cut approximately $2.4-2.5 trillion dollars in spending over the next ten years. That is not an insignificant number but do not forget that the increase in the debt ceiling is the precursor to a net increase of approximately $2.1 trillion in the short term. We are poised to continue digging deeper in an attempt to get ourselves out of this hole.

Net net, our overall debt will be lowered by approximately $400 billion. Any decrease in debt and spending is a HUGE step for our circus showmen who typically have only known how to hand out favors and pile up pork while screwing our children and children’s children.

The flow of that money, whether wisely or unwisely spent, has been akin to a flow of oxygen into our economy. Given the fact that the funds are all borrowed, the oxygen flow has effectively been laced with a silent but ultimately deadly killer in the form of excessive debt which has ballooned our nation’s balance sheet. You certainly would not and could not run your own business in such a fashion. Despite the fact that the oxygen is laced with a ‘poison’, that is the excessive debt, the simple fact is lessened oxygen flow means a greater likelihood of a slowing economy.

How might the ratings agencies react to this debt deal? Recall that these agencies have previously stated that they needed to see credible reductions in spending of upwards of $4 trillion in order for us to maintain our AAA rating. With spending cuts in this debt deal projected to run only up to $2.5 trillion, how do the ratings agencies maintain credibility if they do not downgrade our debt to a AA level?

If that were to happen, Terry Belton, an interest rate and derivatives strategist at JP Morgan (an individual with whom I worked and for whom I have untold respect) projects that our longer term interest rates will increase by 50-70 basis points (.5-.7%). Those increased costs of funding our debt will go a LONG way in eliminating the savings as currently projected in this debt deal. Do you get the sense we are merely treading water as we go down a sinkhole?

What does this all mean? What do I foresee on our near term economic landscape and how can we truly change the game to salvage our economic future?

In the short term, do not be surprised that Ben Bernanke undertakes a third round of quantitative easing in an attempt to support the economy but also monetize the debt. This QE3 may further prop asset valuations but would further pressure the value of the dollar and once again spur inflation. You’ll be getting screwed once again when you go to the pump or your local market.

Over the longer haul, truly meaningful debt reduction relative to GDP needs to be addressed from both ends. Serious reform in entitlement spending needs to happen. I only see that happening via a means testing. In terms of generating real growth (not the phoney government induced growth which we have seen over the last few years), we need meaningful reform in our tax code so we can compete globally.

Can these reforms happen in a Washington which is in bed with so many partners and involved in so many different incestuous relationships? I do not believe so.

As we have seen over the last few weeks, Washington is clearly more the problem than the solution. Public service was never meant to be a career in which the showmen fill their personal coffers and trade their favors.

Washington and America need meaningful change that will only come from imposing term limits. Then perhaps we may be able to truly enact the reforms highlighted above because our public servants will not be beholden to their incestuous partners but rather the American public.

We owe nothing less to our children so that they too may have a chance to pursue the American dream.

On that note, navigate accordingly.

Questions, comments, constructive criticisms encouraged and appreciated.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.


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